Understanding Currency and Supply


Money is like the blood of the economy. Understanding how central banks and financial institutions supply money can help you better understand economic flows. In this article, we will explore methods of money supply and their significance.


1. Two Methods of Money Supply

Money supply is divided into base money and derivative money. Base money refers to the money directly issued by the central bank. This includes physical bills and coins, as well as the central bank’s digital currency. On the other hand, derivative money is created by financial institutions through lending and investment.

Base Money

The central bank supplies base money through various methods. Representative methods include printing money, quantitative easing (large-scale asset purchases), and open market operations (buying and selling bonds). Although base money is only a part of the total money supply, it has a significant impact on the economy.

Derivative Money

Derivative money is generated when financial institutions provide loans to households and businesses. When the borrowed money returns to the financial institutions in the form of deposits, new loans become possible. This process circulates money and stimulates economic activity.

2. Actual Amount of Money Supply

There are several methods to measure the amount of money supply. Representative examples include M1, M2, Lf, and L. M1 refers to the most basic money supply, including currency and demand deposits. M2 adds time deposits to M1, providing a broader sense of the money supply.

M1 and M2

In Korea, M1 is about 1,194 trillion won, while M2 reaches 3,802 trillion won. This shows that most of the money circulating in the economy is derivative money. M2 includes time deposits with fixed maturities and is used as a more comprehensive indicator than M1.

Lf and L

Lf includes long-term financial products with maturities of over two years and life insurance reserve funds, totaling 5,177 trillion won. L adds bonds to this, reaching 6,622 trillion won. These data illustrate the scale and complexity of the money supply.

3. Importance of Money Supply

The amount of money supply directly affects economic stability. When money deposited in financial institutions circulates through loans and investments, the economy moves actively. However, when defaults and bankruptcies are frequent and delinquency rates increase, loans are recalled, investments are avoided, and the money supply rapidly decreases.

Case of Japan

The long-term recession and deflation Japan experienced since the 1990s stemmed from a reduction in the money supply. This is a prime example of the importance of money supply. Changes in central bank policy rates and financial institutions’ lending activities greatly impact the economy and can determine economic recovery or recession.


Money supply is a crucial element of the economy. Understanding how the central bank’s base money and financial institutions’ derivative money are supplied and circulated can help you better understand economic flows. Changes in the money supply directly impact the economy, promoting economic stability and growth.

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