Question

7- Why is the financial sector important in more economic debates? Why are more economists concerned with the total amount of flows coming out of retiring to spending? What is money? What is a liquid financial asset? Why do people hold their assets in form of 8 money? 9 The major measures of money are M1 and M2 what are the major components of each of these measures? Why do economists focus their attention on M2? 10- Explain how banks create money. Compare the effect on the money supply of accepting a cash deposit with that of making a loan?

Answer 1

7) Financial sector acts as a major investment area scope for everyone. If one invests in this sector than, large sums of money is earned as profit and investment. Finances and in a way demand for a stock price drives the company going ahead and the economy. The money which comes off retirement which is in some form hoarded if not in retirement accounts is circulated in the economy once it comes out of retirement. The consumption in the economy grows thereby driving the economy when it is spent. That is why economists are concerned that it is spent wisely and not just hoarded.

8) Money is the most liquid form of asset which one can own. Everyone demands money unlike other forms of assets such as land and machinery. Liquid asset is one which can be easily traded from one person to other. Which is why people hold their assets in money form as it doesn't get stuck while transmitting as everyone demands money.

9) M1 contains physical currency, travelers check, demand deposits, it measures the most liquid components. M2 consists of household holdings of saving deposits, small time deposits and mutual funds which are retail and it contains M1 components as well. It is used for monetary policy as it indicates the rate of money supply and future inflation. If M2 increases faster than rate of growth than prices are higher which leads to inflation which is why economists focus on it.

10) Banks create money by taking in deposits at a lower interest rate and using that money to give a loan at a higher interest rate. Money supply reduces when the money is deposited in the bank account as banks hold it as reserves, when they loan it money supply increases as that money is invested and circulated in the economy.