Money Supply

Money Supply

Money Supply, the amount of money freely circulating in an economy. Money includes notes and coins, and also bank deposits. It is graded according to its liquidity: very liquid assets are narrow money; money that includes less liquid assets is broad money. The broader money is, the harder it is to measure or control.

Narrow money is commonly referred to as M1 and is usually defined as holdings of notes, coins, and “sight” deposits (cheque accounts from which money can be withdrawn on demand) in the non-bank private sector. Broad money is commonly referred to as M2 and includes M1 plus time and savings deposits, and foreign currency deposits of residents.The even broader measures of M3 and M4 include other liabilities of financial institutions. However, different countries define narrow money and broad money in their own ways; for example, in Australia M2 includes certificates of deposit, and in Germany, M1 includes deposits that can be withdrawn on up to one month’s notice. In the United Kingdom, both M0 and a more narrowly defined M2 (and not M1) are used as the measures of narrow money. M0 is cash in circulation, plus the operational deposits of banks that are held by the Bank of England, the central bank. Britain’s measure of broad money, M4, includes the sterling liabilities of banks and building societies to residents.

Control of the money supply is one aspect of monetary policy, which the monetary authorities may seek to carry out by targeting particular measures or an aggregate measure and using the tools available to them to keep the money supply on target. The options monetary authorities have to control or influence the money supply include: adjusting the level of reserves that commercial banks must maintain relative to the loans they make; buying or selling government bonds in the open market; influencing interest rates; and imposing credit controls, such as total personal credit or total bank lending.

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How much growth in the money supply matters is disputed by economists. According to the quantity theory of money, which lies at the heart of monetarism, changes in the money supply ultimately affect only prices, and, therefore, an increase in the money supply will, in the longer term at least, lead to higher prices not higher output. Advocates of Keynesianism, on the other hand, take a different view.

Money Supply