The money supply or money stock refers to the total amount of money that is circulating in an economy at a given point in time. It includes physical currency, such as banknotes and coins, as well as demand deposits held by individuals and businesses in banks and other financial institutions.
In other words the money supply is commonly defined to be a group of safe assets that households and businesses can use to make payments or to hold as short-term investments.
Money Supply influences Stock Markets and Indexes, thus it’s crucial for every investor to understand the concepts of it.
Money supply measure standard
There is no single “correct” measure of the money supply. Instead, there are several measures, classified along a spectrum or continuum between narrow and broad monetary aggregates. Narrow measures include the most liquid assets like currency or checkable deposits. Broader measures add less liquid types of assets.
This continuum corresponds to the way that different types of money are more or less controlled by monetary policy of the Central Bank. Narrow measures include those more directly affected by monetary policy, whereas broader measures are less closely related to monetary-policy actions.
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 MB -monetary base
- M1 - M0 + Demand deposits + Saving Deposits + Other checkable deposits (OCDs) + travelers checks of non-bank issuers
- M2 - M1 + Time deposits less than $100,000 and money-market deposit accounts for individuals
- M3 - 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 Money Aggregates like:
- 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.
This explain the M2 growth in april 2020
Importance of M1
M1 is a narrow measure of money supply used to gauge the amount of physical currency and demand deposits in circulation in an economy. M1 consists of the sum of currency in circulation and overnight deposits, which are deposits held in banks and other financial institutions that can be withdrawn immediately on demand.
M1 is considered a crucial indicator of the level of economic activity because it represents the money that is most commonly used in day-to-day transactions, such as buying goods and services, paying bills, and transferring funds. As such, changes in M1 can be an early indication of changes in consumer spending patterns, which can have a significant impact on the overall health of the economy.
Central banks and policymakers use M1 to assess the effectiveness of monetary policy tools, such as changes in interest rates, and to ensure that the supply of money in the economy remains stable, which is essential for maintaining price stability and avoiding inflation.
M1 is sometimes referred to as the “transaction money” as it is the money most often used for everyday transactions.
Usage of M2
M2 is an important measure of the money supply in an economy because it provides a broader view of the money circulating within the economy than the narrower M1 measure. M2 includes not only the components of M1 (physical currency in circulation and demand deposits), but also time deposits, savings deposits, and other deposits that are not included in M1.
Time deposits are deposits with a fixed maturity date, such as certificates of deposit (CDs), while savings deposits are deposits that do not have a fixed maturity date and often earn interest. Other deposits that are included in M2 may consist of institutional money market funds, repurchase agreements, and other short-term liquid assets.
The inclusion of these additional components in M2 provides a more comprehensive measure of the money supply in an economy, which can be useful for policymakers and economists when analyzing the health and stability of the economy. For example, an increase in M2 may indicate that there is more liquidity in the economy, which can be an early sign of inflationary pressures.
M2 can also be used to analyze the savings behavior of households and businesses. Increases in savings deposits and time deposits in M2 may suggest that consumers and businesses are saving more, which can have implications for investment and economic growth.
In summary, M2 is an important measure of the money supply in an economy because it provides a more comprehensive view of the amount of money circulating within the economy and can be used to analyze the health and stability of the economy and savings behavior of households and businesses.
M2 is often used as an indicator of overall economic activity and is sometimes referred to as the “broad money”.
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 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.