Intro

The money supply is the total amount of money available in a country’s economy at a specific time. This includes cash, like bills and coins, and also money that people and businesses keep in bank accounts.

Basically, the money supply is a collection of safe, easily accessible money that people and companies can use to pay for things or save for a short time.

Understanding how much money is available in the economy is important because it can affect the stock market, which is where people buy and sell pieces of companies. So, knowing about the money supply can help investors make better decisions.

Money supply measure standard

The money supply has multiple definitions ranging from “narrow” to “broad” measures, with narrow measures including the most liquid assets like cash and checkable deposits, which are closely controlled by central bank policies, while broader measures include less liquid assets and are less directly influenced by monetary policy.

The different monetary aggregates are typically classified as “M"s. The “M"s usually range from M0 (narrowest) to M2 (broadest) but which “M"s are actually focused on in policy formulation depends on the country’s central bank.

Typical Monetary Aggregates Layout

The typical layout for each of the “M"s is as follows:

  • M0 sometimes also called MB -monetary base
  • M1 Includes M0 + Demand deposits + Saving Deposits + Other checkable deposits (OCDs) + travelers checks of non-bank issuers
  • M2 Includes M1 + Time deposits less than $100,000 and money-market deposit accounts for individuals
  • M3 Includes M2 + large time deposits, institutional money market funds, short-term repurchase agreements (repo), and larger liquid assets.

Now let’s check the most important currencies

US Federal Reserve definition of Money supply

Fed Defines US Money Aggregates as the follow:

  • M0 The total of all physical currency including coinage. It is not relevant whether the currency is held inside or outside of the private banking system as reserves.
  • MB The total of all physical currency plus Federal Reserve Deposits. See monetary base
  • M1 M0 + plus the amount of demand deposits, travelers checks and other checkable deposits + most savings accounts!
  • M2 M1 + money market accounts, retail money market mutual funds (MMF), and small denomination time deposits (certificates of deposit (CD) of under $100,000).
  • M3 M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements. FIY FED is not using M3 anymore
  • MZM Money Zero Maturity defined as M2 – time deposits + money market funds. is one of the most popular aggregates in use by the Fed because its velocity has historically been the most accurate predictor of inflation.

Prior to 2020, savings accounts were counted as M2 and not part of M1 as they were not considered "transaction accounts" by the Fed. On April 24, 2020, the regulatory distinction was removed by deleting the six-per-month transfer limit on savings deposits and savings account deposits that were included in M1.

This explain the M2 growth in april 2020

_Chart: Currency, M1, M2 developement_

Importance of M1

Watching M1, the narrowest measure of the money supply, is important because it reflects the amount of liquid money—cash and deposits available for immediate spending—in the economy. Since M1 includes the money most commonly used for daily transactions, tracking it provides insights into consumer spending behavior, a major driver of economic activity.

When M1 increases, it often indicates that people and businesses are holding more money that they can quickly spend, which can lead to higher spending levels. This increase in spending can boost economic growth, but if it grows too quickly, it can also lead to inflation, where prices rise too fast. Conversely, a decline in M1 might suggest slower spending and possibly a cooling economy.

Central banks monitor M1 to understand how monetary policy—like interest rate changes—affects spending and liquidity. This helps them manage the economy more effectively, aiming for a balance that promotes growth without causing excessive inflation. By watching M1, they can make more informed decisions to stabilize the economy, benefiting both consumers and businesses.

Recent trends in the M1 money supply have garnered attention due to their potential implications for the stock market. Historically, significant declines in M1 have often preceded economic downturns and stock market volatility. For instance, during the Great Depression, a notable contraction in M1 was observed.

Usage of M2

M2 is a broader measure of the money supply than M1, and it includes not only the most liquid assets but also slightly less liquid assets. M2 is tracked because it gives a more comprehensive picture of the money available in the economy for spending and investment.

Central banks monitor M2 to understand the broader money supply and its potential impact on inflation, economic growth. For example, rapid increases in M2 can signal excessive liquidity, which might contribute to inflation, prompting the central bank to consider tightening measures. Conversely, a decline in M2 might indicate reduced consumer confidence or tighter financial conditions, potentially leading to slower growth.

Eurozone Money Supply

There are three main monetary aggregates used in the Eurozone:

  • M1 Comparable to the US. EU M1 includes currency, as well as overnight deposits.
  • M2 M1 plus deposits with an agreed maturity up to two years plus deposits redeemable at a period of notice up to three months.
  • M3 M2 plus repurchase agreements plus money market fund (MMF) shares/units, plus debt securities up to two years

Differences in the USA and EU definitions

The composition of M1 in the USA and the Eurozone is similar in that it includes physical currency in circulation and demand deposits. However, there are some key differences between M1 in the two regions.

  • The definition of Physical currency in circulation differs. In the USA it includes all coins and paper currency that are in the hands of the public, including those held by financial institutions. In contrast, in the Eurozone, only includes banknotes and coins held by non-bank entities such as individuals and businesses.

  • The composition of demand deposits in M1 also differs between the two regions. In the USA, demand deposits include all deposits held in commercial banks, savings banks, and credit unions that can be withdrawn on demand, regardless of the size of the deposit. In the Eurozone, however, M1 only includes overnight deposits, which are deposits that can be withdrawn on demand but have no specified maturity or withdrawal notice.

Money Supply in Japan

In Japan, the money supply is defined and measured by the Bank of Japan (BOJ):

  • M1 Comparable to ASA but without including interest-bearing accounts, making it a slightly narrower measure of transaction-ready money.
  • M2 M1 (cash and demand deposits) plus quasi-money, such as time deposits and savings deposits at commercial banks (including city banks)
  • M3 M2 and additional deposits from financial institutions beyond commercial banks, such as Japan Post Bank and credit unions.
  • L (Liquidity) This measure goes beyond M3 to include not only deposits but also more liquid financial instruments, like government securities and foreign bonds, and thus reflects the total liquidity available in the economy.

The Bank of Japan often focuses on M2 when discussing the money supply, as it captures both cash and a wide range of bank deposits while avoiding some of the volatility seen in the broader measures like M3 and L. M2 is considered a reliable indicator of the total money circulating within Japan’s economy and helps in gauging the effectiveness of the BOJ’s monetary policy.

Money Supply in China

In China, the money supply is defined and managed by the People’s Bank of China (PBOC):

  • M0 Physical currency in circulation, including coins and banknotes held by the public, but excluding those held in banks.
  • M1 M0 plus demand deposits in commercial banks.
  • M2 M1 plus time deposits and other savings deposits in commercial banks.
  • M3 M2 plus broader financial assets such as money market mutual funds and financial institution deposits.

The PBOC primarily focuses on M2 as a key indicator of money supply.

Money Supply in India

In India, the money supply is defined and managed by the Reserve Bank of India (RBI):

  • M0 Physical currency in circulation, including coins and banknotes held by the public, as well as cash reserves held by banks with the RBI.
  • M1 M0 plus demand deposits in commercial banks and other deposits with the RBI.
  • M2 M1 plus savings deposits with post office savings banks.
  • M3 M2 plus time deposits in commercial banks. This is the broadest and most commonly used measure in India, reflecting the total money available for spending and savings.

The RBI primarily focuses on M3 as a key indicator of money supply.