In economics, money supply or money stock , is the total amount of money available in an economy at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits.
Money supply data are recorded and published, usually by the government or the central bank of the country. Public and private-sector analysts have long monitored changes in money supply because of its possible effects on the price level, inflation and the business cycle.
That relation between money and prices is historically associated with the quantity theory of money. There is strong empirical evidence of a direct relation between long-term price inflation and money-supply growth. These underlie the current reliance on monetary policy as a means of controlling inflation. This causal chain is however contentious, with heterodox economists arguing that the money supply is endogenous and that the sources of inflation must be found in the distributional structure of the economy.
Empirical measures
Money is used in final settlement of a debt and as a ready store of value. Its different functions are associated with different empirical measures of the money supply. Since most modern economic systems are regulated by governments through monetary policy, the supply of money is broken down into types of money based on how much of an effect monetary policy can have on each. Narrow measures include those more directly affected by monetary policy, whereas broader measures are less closely related to monetary-policy actions. Each measure can be classified by placing it along a spectrum between narrow and broad monetary aggregates . The different types of money are typically classified as Ms . The number of Ms usually range from M0 (narrowest) to M3 (broadest) but which Ms are actually used depends on the system. The typical layout for each of the Ms is as follows:
- M0 : Notes and coins (currency) in circulation and in bank vaults. In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.
- MB : Equals M0 + reserves which commercial banks hold in their accounts with the central bank (minimum reserves and excess reserves). MB is referred to as the monetary base or total currency. This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.
- M1 : M1 includes funds that are readily accessible for spending. M1 consists of: (1) currency outside Federal Reserve Banks, and the vaults of depository institutions; (2) traveler's checks of nonbank issuers; (3) demand deposits; and (4) other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts. Bank reserves are not included in M1.
- M2 : Equals M1 + savings deposits, time deposits less than $100,000 and money market deposit accounts for individuals. M2 represents money and "close substitutes" for money. M2 is a broader classification of money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions. M2 is a key economic indicator used to forecast inflation.
- M3 : Equals M2 + large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. M3 is no longer published or revealed to the public by the US central bank. However, it is estimated by the web site Shadow Government Statistics.
- MZM : Money with zero maturity. This measure equals M2 plus all money market funds, minus time deposits. It measures the supply of financial assets redeemable at par on demand.
Fractional-reserve banking
Main article: Fractional-reserve bankingThe different forms of money in government money supply statistics arise from the practice of fractional-reserve banking. Whenever a bank gives out a loan in a fractional-reserve banking system, a new sum of money is created. This new type of money is what makes up the non- M0 components in the M1-M3 statistics. In short, there are two types of money in a fractional-reserve banking system:
In the money supply statistics, central bank money is M0 while the commercial bank money is divided up into the M1-M3 components. Generally, the types of commercial bank money that tend to be valued at lower amounts are classified in the narrow category of M1 while the types of commercial bank money that tend to exist in larger amounts are categorized in M2 and M3 , with M3 having the largest.
Reserves are deposits that banks have received but have not loaned out. In the USA, the Federal Reserve regulates the percentage that banks must keep in their reserves before they can make new loans. This percentage is called the minimum reserve. This means that if a person makes a deposit for $1000.00 and the bank reserve mandated by the FED is 10% then the bank must increase its reserves by $100.00 and is able to loan the remaining $900.00. The amount of money the banking system generates with each dollar of reserves is called the money multiplier, and is calculated as the reciprocal of the minimum reserve. For a reserve of 10% the money multiplier, followed by the infinite geometric series formula, is the reciprocal of 10%, which is 10.
Example
Note: The examples apply when read in sequential order.
M0
- Laura has ten US $100 bills, representing $1000 in the M0 supply for the United States. (M0 = $1000, M1 = $1000, M2 = $1000)
- Laura burns one of her $100 bills. The US M0, and her personal net worth, just decreased by $100. (M0 = $900, M1 = $900, M2 = $900)
M1
- Laura takes the remaining nine bills and deposits them in her checking account at her bank. The bank then calculates its reserve using the minimum reserve percentage given by the Fed and loans the extra money. If the minimum reserve is 10%, this means $90 will remain in the bank's reserve, and the remaining $810 can be used by the bank as lending money. The M1 money supply increased by $810 when the loan was made (assume no further loans); money has been created. (M0 = $900, M1 = $1710, M2 = $1710)
- Laura writes a check for $400, check number 7771. The total M1 money supply didn't change, it includes the $400 check and the $500 left in her account. (M0 = $900, M1 = $1710, M2 = $1710)
- Mandy's check number 7771 is destroyed in the laundry. M1 and her checking account still have $900 because the check is never cashed. (M0 = $900, M1 = $1710, M2 = $1710)
- Mandy writes check number 7772 for $100 to her friend Alice, and Alice deposits it into her checking account. M0 still has that $900 in it, Alice's $100 and Laura's $800. (M0 = $900, M1 = $1710, M2 = $1710)
- Laura deposits her paycheck for $5,000 in her checking account. That part of M1 money came from her employer's checking account. (M0 = $5900, M1 = $11210, M2 = $11210)
M2
- Laura writes check number 7774 for $1000 and brings it to the bank to start a Money Market account. M0 goes down by $1000, but M2 stayed the same, because M2 includes the Money Market account, but also everything in M1. (M0 = $4900, M1 = $6710, M2 = $6710)
Foreign Exchange
- Laura writes check number 7776 for $200 and brings it downtown to a foreign exchange bank teller at Credit Suisse to convert it to British Pounds. On this particular day, the exchange rate is exactly USD $2.00 = GBP £1.00. The bank Credit Suisse takes her $200 check, and gives her two £50 notes (and charges her a dollar for the service fee). Meanwhile, at the Credit Suisse branch office in Hong Kong, a customer named Huang has £100 and wants $200, and the bank does that trade (charging him an extra £.50 for the service fee). US M0 still has the $900, although Huang now has $200 of it. The £50 notes Laura walks off with are part of Britain's M0 money supply that came from Huang.
- The next day, Credit Suisse finds they have an excess of GB Pounds and a shortage of US Dollars, determined by adding up all the branch offices' supplies. They sell some of their GBP on the open FX market with Deutsche Bank, which has the opposite problem. The exchange rate stays the same.
- The day after, both Credit Suisse and Deutsche Bank find they have too many GBP and not enough USD, along with other traders. To move their inventories, they have to sell GBP at USD $1.999, that is, 1/10 cent less than $2 per pound, and the exchange rate shifts. None of these banks has the power to increase or decrease the British M0 or the American M0; they are independent systems.
Money supplies around the world
United States
File:Currency component of the US money supply 1959-2009.gif
The Federal Reserve previously published data on three monetary aggregates, but on 10 November 2005 announced that as of 23 March 2006, it would cease publication of M3. Since the Spring
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