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AS & A-Level Economics — Money, Banking and Macroeconomic Trade-Offs

AS & A-Level Economics — Money, Banking and Macroeconomic Trade-Offs

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Original Deckloop economics study material on money, banking and macroeconomic trade-offs, with 120 practice cards and 24 concept explainers. Includes worked applications and analytical reasoning.

Economics EN A-Level
120 cards
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Example Explainer

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Measuring Money: Narrow vs. Broad

Economists measure the money supply to understand the amount of purchasing power available in an economy, which influences inflation, interest rates, and economic growth. Money supply measures are categorised by liquidity. Narrow money (e.g., M0, M1) includes the most liquid assets: physical currency in circulation and highly accessible deposits like current accounts (sight deposits). These are readily available for immediate transactions. Broad money (e.g., M2, M3, M4) encompasses narrow money plus less liquid assets, such as savings accounts, time deposits, and money market funds. These assets require a short period to convert into cash or may incur penalties for early withdrawal, making them less immediate for transactions but still representing potential purchasing power. Different measures provide varying insights into the economy's monetary conditions.

Key points

  • Money supply measures indicate the total amount of money in an economy.
  • Narrow money includes the most liquid assets: currency and sight deposits.
  • Broad money includes narrow money plus less liquid assets like savings and time deposits.
  • Liquidity refers to the ease and speed with which an asset can be converted into cash without loss of value.
  • Central banks monitor various money supply measures to inform monetary policy decisions.

Worked example

Question

The central bank of 'Veridia' reports the following monetary aggregates for the last quarter: Currency in circulation = 300 billion monetary units; Overnight deposits = 850 billion monetary units; Deposits with agreed maturity up to two years = 500 billion monetary units; Deposits redeemable at notice up to three months = 200 billion monetary units; Repurchase agreements = 100 billion monetary units. Calculate Veridia's M1 and M3 money supply, assuming M1 = Currency in circulation + Overnight deposits, and M3 = M1 + Deposits with agreed maturity up to two years + Repurchase agreements.

Solution

1. Identify the components for M1: Currency in circulation and Overnight deposits.
2. Sum these components to calculate M1.
3. Identify the components for M3: M1, Deposits with agreed maturity up to two years, and Repurchase agreements.
4. Sum these components to calculate M3.

To calculate Veridia's M1 and M3 money supply:

M1 = Currency in circulation + Overnight deposits
M1 = 300 billion monetary units + 850 billion monetary units
M1 = 1,150 billion monetary units

M3 = M1 + Deposits with agreed maturity up to two years + Repurchase agreements
M3 = 1,150 billion monetary units + 500 billion monetary units + 100 billion monetary units
M3 = 1,750 billion monetary units

Therefore, Veridia's M1 is 1,150 billion monetary units, and its M3 is 1,750 billion monetary units.

Common pitfalls

  • Misconception: All money supply measures include the same assets. Correction: Money supply measures are distinguished by the liquidity of the assets they include, with narrow measures focusing on the most liquid and broad measures including less liquid assets.
  • Misconception: The terms 'narrow' and 'broad' money refer to the physical size or quantity of currency. Correction: These terms refer to the scope of assets included in the measure, specifically their liquidity and accessibility for spending, not their physical attributes.

Prerequisites

  • Deck 15 — Functions and Characteristics of Money: To categorize different forms of money into narrow and broad measures, one must first understand the general concept of money and its functions.
  • Basic arithmetic: Basic arithmetic (addition) is needed to sum components when calculating money supply measures like M1 and M3 in the worked example and card 2.