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The Difference Between Money Supply & Liquidity

THE DIFFERENCE BETWEEN MONEY SUPPLY & LIQUIDITY

The US debt ceiling suspension, signed on February 2018, expires in March this year. According to some experts, the US Treasury will have to carry out special measures because of possible delays in raising this ceiling. Treasury would need to draw down its deposits with the Fed and deposit the money in various banks for future use to pay government expenses. As a result, this would boost monetary liquidity and therefore would have beneficial effects on financial markets.

It is sometimes argued that changes in government deposits with the Federal Reserve (Fed) set in motion changes in liquidity and that this has effects on financial markets. On this logic an increase in government deposits with the Fed would lead to a decline in the supply of money and hence to a decline in monetary liquidity.

Conversely, a decline in government deposits with the central bank results in an increase in money supply and monetary liquidity. An implicit assumption in this logic is that an increase in money supply and an increase in liquidity represent the same thing.

The meaning of monetary liquidity

Whilst many people talk about money and liquidity interchangeably, the reality is these are both very different concepts. Whilst the term money simply refers to the supply of money, the term liquidity relates to the interplay between the supply of and the demand for money.

People demand money primarily in order to facilitate trade. By means of money, a product of one specialist is exchanged for the product of another specialist. The nub of what makes a particular thing money (i.e. a medium of exchange) is that it offers to its holder a greater purchasing power than any other good.

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