Money supply refers to the volume of money held by the public at a particular time, this includes the currency in circulation (physical cash) and demand deposits (the assets on the books of financial institutions). The record of money supply is kept by the Central Bank of the country.
Changes in the money supply have been seen as a key factor in driving the economy and business cycles. In the past, measuring the money supply has shown correlation between money supply and inflation as well as between money supply and price levels. However, over the last couple of decades, the relationship between money supply and inflation has become less predictable, making it less reliable as a guide for monetary policy. For this reason, monitoring money supply is used along side other economic measures, which allows for a broader, more accurate picture of the economy.
When the supply of money circulating increases, we typically see lower interest rates, which then generates more investment and puts more money back into circulation for consumers, which then leads to more spending. However, we can see the inverse of this when money supply falls or growth rate declines. When this happens, banks lend less, consumer demand declines, and people tend to hold on to their money rather than spending it, decreases again the amount of money in circulation. Further effects can be seen as businesses slow growth or lay off employees and home and car loans decline.
