bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

3
The Money Supply
Process
THE MONEY SUPPLY PROCESS 49
'Central banks almost everywhere usually implement their policies
through tight control of money market interest rates. Academic monetary
economists almost everywhere discuss monetary policy in
terms of the monetary stock. These facts say something about
either central bankers or academic monetary economists, or both.'
W Poole (1991).
What you will learn in this chapter:
• How changes in the quantity of money involve changes in banks' balance sheets
• How the quantity of broad money can be expressed as a multiple of the
monetary base
• How the size of this multiple depends upon underlying portfolio preferences
• How the flow of new money can be analysed as the outcome of bank lending
• How these two approaches can be formally reconciled
• But why each is more appropriate to the analysis of a particular type of
monetary regime.
3.1 Introduction
In the last chapter we saw that we encounter many problems when trying to
define money, especially if we are looking for a definition which actually
specifies the assets that should be included rather than simply specifying
money's functions. However, we also saw that if the authorities wish to conduct
any sort of monetary policy they have to decide which assets they are
going to monitor, even if this involves a degree of arbitrariness and requires
the frequent redrawing of boundaries.
In practice, most monetary authorities work with three measures of
money. These are the monetary base, and some measure of narrow and
broad money. For convenience, these are usually identified by numbers.
Starting from the narrowest measure, M0 is used to denote the monetary
base and consists only of notes and coin outside the central bank plus banks’
deposits held with the central bank. Narrow money, M1, consists of notes
and coin in circulation outside the banking system together with the nonbank
public’s holdings of bank sight deposits. M0 and M1 have pretty
much the same meaning in all monetary systems. The same cannot be said
of the measure of broad money. In the majority of countries this is denoted
M3, while in the UK it is denoted M4 and, while we can say that the difference
between broad and narrow money is that the former includes time