(UPSC Economics Optional 2014) Question No. 2

Explain the H theory of Money Supply.

Note: Unlike the first question, this one is straight forward and the answer can be found in any books Macro book by Ahuja, Jhingan or Monetary Economics book of S B Gupta. Surprisingly, the respective pages of SB Gupta's text are found here.

Answer:

Supply of money is policy determined.H^s = H. There is bar above H which means its exogenous to the public and banks.

H^d is the demand for H, which is the sum of the currency demanded by the public (C) and by banks as reserves (R).

C= c.DD

R= r.D---- (1)

TD= t.DD

D= DD+TD

   =(1+t) DD

(1) becomes R = r (1+t) DD

We have H^d = C + R = [c+ r( 1+t) ] DD

H^s = H^d implies,

H= [c+ r( 1+t) ] DD

From above,

DD= H/ [c+ r( 1+t) ] which is the equilibrium value of DD in terms of H and 1/ [c+ r( 1+t) ]  is called the demand- deposit multiplier.

We know Ordinary Money is M = C + DD = (1+c)DD = (1+c)H/[c+ r( 1+t) ] 

and the expression (1+c)/[c+ r( 1+t) ]  gives the money multiplier or m.

We have M =(1+c)H/[c+ r( 1+t) ]  which is rewritten as m. H 

M= m. H

Implications:

1. The monetary authority has to assume m as exogenously determined and that it will influence M.

2. m depends on behavioral choices of the public and banks.