The national money supply is the amount of money available for consumers to spend in the economy. In the United States, the circulation of money is managed by the Federal Reserve Bank. An increase in money supply causes interest rates to drop and makes more money available for customers to borrow from banks.
The Federal Reserve increases the money supply by buying government-backed securities, which effectively puts more money into banking institutions. An increase in paper money reduces the value of the U.S. dollar, but increases the money banks can lend to consumers. When banks have more money to loan, they reduce the interest rates consumers pay for loans, which typically increases consumer spending because money is easier to borrow. The government will request an increase in the money supply when the economy begins to slow to spur additional spending by consumers and build confidence in the economy.
An increase in money supply can also have negative effects on the economy. It causes the value of the dollar to decrease, making foreign goods more expensive and domestic goods cheaper. With the complex global economy, this can ripple out and affect other nations. Steel, automobiles, and building materials can all cost more. As a result, the prices for home building and real estate increase because of increased material and building expenses. It does make it easier for customers to get loans, however, because banks are more willing to loan money.
Successfully managing the global economy requires effective monetary polices. An increase in the money supply is only one of many options available to government policy makers. They can also modify tax rates, adapt foreign trade restrictions, modify bank reserve requirements, and change the federal interest rate.
If an increase in money supply is too drastic, it can lead to deflation in the economy because the value of the country's currency can drop when compared to that of other countries. This causes products of the home nation to become cheap and attractive to foreign investment.
The Federal Reserve in the US has been monitoring the money supply for many decades. This supply ratio has a direct effect on the growth of the economy and gross domestic product. The goal is to balance the available money with interest rates to ensure steady growth.