Money supply refers to the total amount of money available in an economy at a given time. It includes currency in circulation as well as deposits that can be used for transactions. There are different measures of money supply that range from narrow to broad definitions. Narrow money (M1) includes currency and checkable deposits, while broader measures add other liquid assets like savings deposits and money market funds. Irving Fisher developed the quantity theory of money, which states that the price level in an economy is directly proportional to the money supply when the velocity of circulation and output are held constant. Doubling the money supply would double the price level according to this theory.

1. Money Supply and Its Determinants
Money supply
Money supply refers to the total sum of money available to the public in the economy at a point
of time. That is money supply is a stock concept in sharp contrast to the national income which is
a flow representing the value of goods and services produced per unit of time, usually taken as a
year.
In the term public are included households, firms, and institutional other than banks and
governments. According to the standard concept of money supply, it is composed of the
following two elements:
1. Currency with the public
2. Demand deposits with the public.
Measuring Money
Different measures of money supply. Not all of them are widely used and the exact
classifications depend on the country. The term broad money is used to describe M2, M3 or M4,
depending on the local practice.
Narrow Money
M0 and M1, also called narrow money.
M0 normally include coins and notes in circulation and other money equivalents that are easily
convertible into cash.
M1 includes all currency in circulation, traveler’s checks, demand deposits at commercial banks
held by the public, and other checkable deposits.
M2 – Intermediate Measure
M2 includes M1 plus short-term time deposits in banks and 24-hour money market funds.
M2 includes everything in M1 as well as savings deposits, time deposits below USD 100,000
and balances in retail money market funds.
Broad Money
M3 includes M2 plus longer-term time deposits and money market funds with more than 24-hour
maturity.
And last but not least, M3 includes everything in M2 and time deposits larger than USD 100,000,
balances in institutional money market funds, and term repurchase agreements.
M4 includes M3 plus other deposits.

2. Fisher’s Equation of Exchange:
An American Economist, Irving Fisher, expressed the relationship between the quantity of
money and the price level in the form of an equation, which is called ‘the equation of exchange’.
This is:
PT = MV ----- (1)
Or, P =
𝑀𝑉
𝑇
----- (2)
Where, P = The average price level
T = Total amount of transaction
M =The quantity of money and
V = The transactions velocity of circulation of money
The equation of (1) and (2) is an accounting identity and true by definition.
MV = Supply of money
PT = Demand for money
Let us give a numerical example.
Suppose , the quantity of money is $500000 in an economy, the velocity of circulation of money
is 5 and the total output to be transacted is 250000 units, the average price level will be:
P =
𝑀𝑉
𝑇
=
$500000𝑥 5
250000
= $10 per unit
If now, other things being equal, the quantity of money is doubled. i.e., increased to $1000000
then:
P =
𝑀𝑉
𝑇
=
$1000000𝑥 5
250000
= $ 20 per unit
We thus see that , accordingly to the quantity theory of money, price level varies in direct
proportion to the quantity of money.
Numerical Example:
Following is the Balance Sheet of a Sonali Bank for the FY( financial year) 2015:
Assets Liabilities
Loans outstanding $91 billion Deposits $ 100 billion
Government bonds 2 billion
Reserves 10 billion Net worth 3 billion
Total 103 billion Total 103 billion
Sonali Bank is one of the nationalized bank of Bangladesh. Bangladesh Bank declared that the reserve of
the Sonali Bank should be 10% of its deposit. Now a multi-multi-millionaire deposits $1billion in her
account. How the bank creates money?