What is money supply?

Money supply is the total stock of money available to spend at a given time. It matters because the amount of money relative to the amount of goods affects prices, interest rates and the pace of activity.

How it works

Central banks create base money, and commercial banks expand it by lending: a deposit can be lent out, and that loan becomes another deposit elsewhere. The size of this expansion depends on how much banks must hold back and how much people want to borrow. Money also leaves the supply when loans are repaid.

If the stock of money grows faster than the output of goods and services, prices tend to rise. If it shrinks, spending and prices tend to fall. The link is not exact, because it also depends on how fast money changes hands, but the stock is a basic quantity that policy tries to steer.

Example

Say a central bank adds 100 of base money and banks must keep 10 percent in reserve. A bank lends 90 of a 100 deposit, that 90 is deposited and 81 is lent, and so on. The total added in deposits is 100 divided by 0.10, which is 1,000 at most. In practice it is lower because people hold some cash and banks hold extra reserves. The reserve rate is an illustration.

How to model it in Machinations

Create a Source for base money creation and a Pool for bank reserves. Use a Converter to turn reserves into loans at a rate set by a reserve-requirement Lever, and let loans flow into a Pool of deposits that feeds the next round of lending. Add a Drain for loan repayment. Play with the reserve rate at 10 and at 20 percent and chart total deposits.