Money supply block

The money supply is regarded as one of the most controversial economic variables, at both theoretical and practical levels (Laidler, 1969). This controversy can be verified by a lack of agreement on the unified and explicit definition of the concept of money; this in spite of the consensus on its importance which is established through its widespread use in all societies (Kaufman, 1969). The money supply is considered one of the important tools of civilization and advancement which can lubricate the exchange process as well as having strong influence on real economic variables (Shostak, 2000).

It should be noted that there is general agreement among economists concerning the functions of money, although some economists try to emphasize the importance of a particular function, irrespective of the two other functions it possesses. Therefore, the author will seek, firstly, to clarify these functions and then, secondly, define which of these assets undertake such functions and, therefore, may be called money.

The function of the standard of values is the first function that has emerged to describe money, where it is regarded as a basis for a comparison between goods when determining their rates of exchange. There is no doubt that the presence of a single measure facilitates this process significantly. Furthermore, it should be noted that the function of the standard of values is, essentially, an accounting function and refers to an abstract unit of money, i.e the barter of goods could only occur by the evaluation of each commodity through monetary units and the money may not be, virtually, in the exchange process; this, really, is a difficult and complex mechanism. Then the function of the medium of exchange came after growth in the needs and the increase in the number and breadth of economic transactions alongside the development of societies which led to the complexity of the process, as mentioned earlier, of the exchange and flow of

165 goods in the markets. Time is regarded as a critical factor in the completion of the process of exchange because economic transactions are, in fact, an extended process over time and there is no guarantee of the continuity of the synchronization in the exchange process that leads, in turn, to the appearance of a new function of money, which is its role as a store of value.

In the same context, the description of an asset as a medium of exchange and a standard of values satisfies all the necessary and sufficient conditions which are required to describe it as money. Whereas describing an asset as a store of value without the inclusion of the other two functions means that it cannot be described as money.

This does not mean that the function of the store of value is insignificant but, on the contrary, this function has been researched greatly in the monetary economics field and there is increasing severity in the disputes around it. It is worthwhile noting that there are other assets which are characterized by being steady in value and are used with money as a store of value, but are not regarded as money. Money is demanded as an asset, often, because of its own characteristics, which results in disagreements about the specific terms used to describe the money concept, which has led to an arising need to accurately define this term; specifically when establishing what is meant by the supply of money.

It can be said, in general, that the differentiation between the functions of money is disputed by two points of view. The first considers that the most important function of money is in its role as a medium of exchange, which is the prevailing view of the monetarists, led by Milton Friedman, Whereas the second point of view attaches importance to the function of the store of values, where money is demanded for its own characteristics. According to this point of view, the narrow money supply concept, which is limited to the currency in circulation

166 and the demand deposits in commercial banks, is not the right foundation which must be adopted by a monetary policy; it must be directed to a wider interest which is concerned with the overall liquidity in an economy; this is urged by the report issued by the Radcliffe committee during its examination of the monetary system in England in 1959.

The concept of liquidity is ambiguous and uncertain and it is difficult to give a precise and comprehensive definition of the idea of liquidity. Analytically, one looks at liquidity on the basis of the degree to which it can be the asset marketed and the possibility of converting it into money in a short time and in its full value. Therefore, when determining the degree of liquidity, the outcome is the extent to which the asset can quickly be converted into a means of payment, and the degree by which it maintains its value during the conversion process. Based on this criterion, any mixture of financial assets may reflect different degrees of liquidity depending on the components that are represented in the financial assets’ mixture.

It should be noted here that assets that accustomed by individuals are actually considered more liquid than others, as the most commonly used assets in a society can be marketed easily at a price close to their purchase price. Consequently, liquid assets, without the function of a medium of exchange, are a perfect alternative to money and the total of these assets can be summed up by individuals’ spending decisions. Thus, the idea of liquidity is considered as a vital basis that a monetary policy can rely upon.

This perspective has developed in monetary policy substantially as a result of the individual contributions of Gurley and Shaw which focused on the possibility of increasing the efficiency of a monetary policy when it has been studied within the financial assets as a whole (Gurly and Shaw, 1970).

167 Moreover, this debate takes a deeper dimension when one refers to the ability of the Central Bank to control the money supply, which led to an attempt to determine the amount of this control which entails knowing whether the money supply is endogenously determined or not. In such a scenario, monetarists treat the quantity of money and its rate of growth as constant variables determined outside (exogenous variable) the model. This is incompatible with the view of non-monetarists who consider that the money supply is determined inside (endogenous variable) the model by the level of economic activity and the preferences of different individuals, through substitution between money and other financial assets (Humphrey, 1975).

In general, the treatment of the money supply as an endogenous variable has proved its importance in many practical studies (Marothia and Phillips, 1982). And, away from the Keynesian radical point of view which is expressed by Nicholas Kaldor, ‘that money doesn’t matter’, it can be said that the view of the post-Keynesians, led by James Tobin, is more reasonable. Many authors have termed this view as an eclectic view (Glahe, 1973) because it comprises the best arguments of both the Keynesians and the monetarists and, therefore, it can be considered that the money supply is an endogenous variable, and that it is then determined inside the model (Brunner and Meltzer, 1972 a).

With regard to the explanatory variables that describe the behaviour of the supply of money, this can be clarified through the actions of the three economic units that affect the money supply. The nominal money stock in a particular time is as a result of the portfolio decisions of the Central Bank, the commercial banks and the public, including non-bank financial intermediaries.

Therefore, these variables should be reflected somehow in the behaviour of these economic units. In this context, many economists have adopted the monetary base and the money supply in the previous period as significant

168 explanatory variables in describing the behaviour of the money supply (Khan, 1974).

In addition, some economists take into account the impact of the interest rate on the money supply (Fand, 1970) as well as the important role of the currency in circulation and the demand and the time deposits, the currency deposits ratio, the currency money supply ratio, and the time deposits money supply ratio. Moreover, these writers also take into consideration some of the monetary policy tools that are represented in the discount rate, in the required reserves, and in the maximum allowable interest rate on time deposits, as crucial explanatory variables.

Also, some studies took into account the excess reserve and the expanded monetary base which includes the monetary base as well as the changes in the amount of liberated reserves that resulted from the changes in the legal reserve, in addition to the transfers that occur in the deposits between the differing levels of commercial banks. Additionally, these liberated reserves can be realized due to the transfers in deposits between member banks in the Federal Reserve’s system (Central Bank) and non-member banks. Additionally, these transfers also occur between time deposits and demand deposits (Andersen, 1967).

The equation for the money supply in this study depends on the stock of the money supply and on the components of the monetary base which are represented by both the stock of foreign assets and net domestic assets in the current period and the previous period. Additionally, the money supply function in this model function the dummy variable expresses the period which covers the lifting of the embargo on Libya and the start of the transition in the Libyan economy. Accordingly, the function will be as follows:

169 Where:

MS = Money supply,

MS_1= Lagged one period of the money supply,

IRC = Balance of foreign assets (reserves),

NDAC= Net domestic assets,

NDAC_1= Lagged one period of net domestic assets, and

D0206 = Dummy variable (1 in 2002 – 2006, 0 elsewhere).