What is Monetary Economics?
As from the name, it is very evident that monetary economics deals with the monetary theory of economics. Therefore, we can say that monetary economics, is that part of economics that provides us with the idea or notion of analyzing money as a holding with its function, which acts as the medium of exchange, the store of value through which the buying and selling are done and also the unit of account. It also helps in formulating the framework of the monetary policy of a bank in an economy which ultimately results in the welfare of the people residing in that particular economy. The monetary policy of an economy also helps to analyze and evaluate the financial health of it.
What is Money?
Since monetary economics deals entirely with an idea of money, finance, monetary policy, and activities related to banks, it is very important to have a clear idea of what money actually is. In simple words, we know that money is the medium of exchange through which we do the economic activity of purchasing and selling goods and services from time to time. Also, money acts as a store of value.
This can be understood with the help of an example: When we go to a shop to buy a certain good for rupees 100, we offer the shopkeeper ₹100 note. This means that, that ₹100 note which we are offering to the shopkeeper is storing the value of ₹100. Now the question comes that from where does this piece of paper gain the value of 100 worth. This is nothing but the government which gives the piece of paper the value of 100 and we the people have complete faith in the government and use it as a medium of transaction for whatever worth of money we are doing the transaction for.
This is known as “fiat money” in which we completely rely upon the government for calculating the value of any amount of money in a particular piece of paper.
There are basically two kinds of functions that the money performs which make the process of transaction or economic transaction easier for individuals to make:
- Primary functions: The primary function basically includes the main two functions of money which are the medium of exchange and the measure of value. Since we know that money is widely accepted as the medium through which most of the purchases and sales are made in an economy; the use of money as a common medium of exchange has facilitated the exchange process or the economic exchange in an economy in a very smooth way. It does not only remove the inconvenience of the barter system that was earlier there but also removes the inefficiency of the barter system.
The second important function that the money functions or performs is that it acts as a measure of value or unit of account which we have already mentioned earlier. When we express the value of a commodity or good in terms of money, it is known as price. Therefore, prices are nothing but the number of money or the amount of money for which one unit of a commodity should be exchanged which is either purchased or sold.
2. Secondary function: The secondary function of money is that it acts as a standard of deferred payments. This means that a payment that has to be made in the future can be mentioned or stated in terms of money. This can be seen in other perspectives which are as an extension of the medium of exchange feature of money. In this case, we get to see that money is used as the medium of exchange but the time of payment is spread over a period.
Now let us understand the concept of the money supply which makes the entire economy run and is basically communicated by the bank or the central bank of a country. One of the most important theories which come under monetary economics is the theory of the supply of money in an economy, how it is done, who controls the supply of money, and so on. The monetary aspect of macroeconomics deals with mainly the supply of money.
Demand for Money
Money is demanded in an economy for several purposes. The classicists assume that people want money for the transaction purpose, but according to Keynes money is not only demanded for purchasing goods and services, but also is demanded to deal with the unforeseen contingencies, and for the speculative motive.
Supply of Money or Money Supply in an Economy
The money supply is known to be the stock of money that is held by the public or we can say which is available to the public for spending at a particular point of time as the mode of payment and the store of value.
There are two important points that beneficial to keep in mind while studying the supply of money:
- The first and the foremost thing which we have mentioned in the definition of supply of money is that the money supply is the concept that gives us the idea about the stock of money or the amount of money that is being held by the public. Now, here, the public doesn't only mean the individuals of an economy, rather it also refers to and includes the private individuals residing in an economy, the business firms which are operating the process of production and contributing to the economy, and also the institutions which deal with the economy.
The individual or the economic units which are not included as public in terms of the supply of money are those who actually produce or create money. It means that the producer or the creators of money are not included as public in the definition of supply of money or money supply. Now, the government, the central bank, and the commercial banks are these producers or creators of money in a monetary economy.
Money supply also refers to the money in circulation but it does not include the money held by the government, the central bank, and the commercial banks. This is because we only take into account the public holding of money.
2. The second important thing which is necessary to keep in mind is that the supply of money is always measured over a particular point in time. For example, the supply of money is measured supposing to be on the day of 12th February 2021.
The most important concept that comes under monetary economics is the concept of monetary policy. This part of economics also deals with the matter that how the monetary policy of an economy works according to the financial aspects of the monetary economy.
In economics, the theory of money deals with the monetary policy of a particular economy. The central bank of a country can regulate the supply of money according to the need of the society at that particular point in time. There are majorly two ways in which the central bank or any bank of a country regulates the money supply in that economy, firstly, by increasing the money supply in an economy, the second way is to decrease the supply of money in an economy.
Expansion of Monetary Policy
The expansion of monetary policy by the central bank is done when the aggregate demand of an economy is extremely low which results in poor functioning of the production and all timidly leads to a decline in the growth of an economy. This kind of stay is taken by the central bank to boost the aggregate demand of an economy. This problem arises especially during a time of crisis when the economy lacks money which means money is scarce in the hands of the people that are disabling them from making any kind of demand. This is a scenario where there is a sufficient supply of goods and services in the economy but people are not able to buy them or purchase them just because they are not having enough money in their hands.
Now the central bank needs to increase the sales and purchases in the country by taking the initiative of expansionary monetary policy which basically means increasing the money supply in an economy so that people do get money in their hands from some way or the other. This kind of monetary policy or expansionary monetary policy takes place in the form of various initiatives by the central bank which it undertakes for providing money in the hands of the people so that they can create the boost of aggregate demand which is beneficial for the economy to run and also which is beneficial for its growth. But it is very important to keep in mind that the expansionary monetary policy should not go to an extreme level because that can lead to inflation. Inflation means a persistent growth in the price level. The increasing money supply should be to that extent only when the gap between the aggregate demand and the aggregate supply is met and again the equilibrium of the economy is retained.
Contractionary Monetary Policy
When the central bank senses that there is an excess supply of money in the economy, it tries to regulate the condition of the economy by decreasing the amount of money available in the economy or to form some kind of leakage in the circulation or circular flow of money which goes on in the economy. The central bank can do this by issuing government bonds in the market or selling government securities in the market to fetch money or reduce the quantity of money holdings of the public. In this way, there will be a shortage of money created in the economy which will give a push up of the interest rate in the economy that will discourage the borrowers to borrow money because the interest rates are too high to be paid.
In macroeconomics, monetary economics deals with how this decrease of the money supply by the bank or central bank is done and also gives us videos, theories that how the interest rate is regulated in the economy at the time of inflation or deflation.
In conclusion, we may say that under macroeconomics, we get to see the banking analysis of the banks and various economist on the theory that how inflation can be regulated, how fiscal policy is different from monetary policy, what are the determinants that define the money supply, how the policymaker judges the quality of a quantitative analysis of any economy to formulate the framework of a particular policy which will be beneficial in the long run and will also lead to economic growth.
Context and Applications
This topic is significant in the professional exams for both undergraduate and graduate courses, especially for
- BA in economics
- MA in economics
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