There is little debate as to whether or not money supply, or the amount of available “money” in circulation in a given economy, changes within the context of inflation and deflation. Of course, the use of the term “money” in money supply is not limited to only denominations of bills and coins backed by precious metals in the Federal Reserve (though, in fairness, this is a big part of the supply).
There are a number of different financial instruments that may be classified under this designation. For one, issuances of credit and loans may be included herein, such as bank deposit accounts, traveler’s checks and security investments. In accord with the monetary policy of the United States, the entire supply is divided into subsets that vary by degree of how they might be spent by the public.
For instance, the M1 aggregate is best symbolized by its main component: notes and coins that are not held within the Fed, banks or any other institution. Those tallies that are contained in federal and federally-insured institutions are grouped differently and are not released to the public.
In terms of how the money supply is tied to credit/debt and inflation, then, it must be understood how regulation at the hands of a Federal bank and its monetary policy may impact the cost of being a borrower or debtor. Specifically, money supply is tied to the national interest rate. With a tightening of the supply, the price of credit, measured by the rate of interest, goes up. Conversely, with a relaxation of the supply, the charge to the debtor/borrower and the interest rate go down.
Yet another relationship is discovered in the monetary policy-inflation/deflation binary, and this is where the nexus of the argument arises. Going back to interest rate modification at the behest of the government, interest rates are formulated correlative to the rate of inflation, so that high interest rates imply a need to lower inflation, while low interest rates signify the necessity of encouraging it.
By extension, this would also seem to say that money supply has a lot to do with regulating price fluctuations. However, some theorists suggest that supply is merely ancillary to the main control of these trends: how funds are distributed, and not necessarily how much.
