The money supply encompasses all the currency and liquid assets circulating within a country’s economy at a specific time. This includes cash in circulation and bank deposits that account holders can readily convert to cash.
Governments distribute paper currency and coins via their central banks or treasuries. To achieve economic stability, banking regulators can alter the money supply through policy changes and regulatory decisions.
Key Insights
- The money supply encompasses the total amount of cash and cash equivalents in an economy at a given point in time.
- Variants of money supply statistics include non-cash items such as credit and loans.
- The U.S. Federal Reserve monitors the money supply monthly and influences it through various actions.
- Monetarists believe rapid increases in the money supply over real income growth can lead to inflation.
Tracking the Money Supply
The Federal Reserve’s website maintains an account of the U.S. money supply, tracing back to 1999. In its publications, the Fed refers to the money supply as the money stock.
Understanding Money Supply
In the United States, the Federal Reserve, or Fed, regulates the money supply. Its economists track how much money flows to determine if excessive money circulation may lead to inflation or insufficient money circulation may cause deflation.
Tools of the Federal Reserve
- Interest Rates: The Fed controls interest rates by setting key rates for overnight loans to banks. Rates of other loans derive from these federal lending rates.
- Cash Flow: By adjusting the cash flow to banks for loans, the Fed impacts businesses and consumers.
The money supply is tracked over time as a key factor in analyzing economic health, identifying weak spots, and fostering policies for improvement.
$19.34 Trillion
As of February 2023, the seasonally-adjusted M1 money supply stood at $19.34 trillion, according to the Federal Reserve.
Impact of Money Supply on the Economy
An increased money supply typically lowers interest rates, fostering more investments and consumer spending, ultimately stimulating the economy. Businesses ramp up production and the demand for labor rises.
Conversely, a decreased money supply can lead to reduced bank lending, postponed business projects, and lower consumer demand for loans, impacting overall economic activity.
Various macroeconomic theories assert that money supply changes are critical for economic performance and business cycles, despite becoming less predictable in recent years.
The Money Supply Components: M1, M2, and Beyond
The Federal Reserve tracks two main metrics of money supply, tagged as M1 and M2. Previously, they reported M3, M0, and MB, although M3 was discontinued in 2006.
M1: Narrow Money
M1 represents all notes and coins in circulation plus easily convertible money equivalents like savings accounts.
M2: Broad Money
M2 includes M1 along with short-term time deposits in banks and money market funds.
M3, M0, and MB
- M3: Included M2 plus long-term deposits, now discontinued.
- M0: Measures actual cash circulation and bank reserves.
- MB: Stores total currency supply including bank reserves at central banks.
Both M0 and MB are encapsulated within M1 and M2 categories.
The Federal Reserve provides the latest M1 and M2 figures weekly and monthly, which are widely reported and available on the Fed’s website.
Determinants of the Money Supply
Economists analyze the components, or determinants, of the money supply:
- Currency Deposit Ratio: The amount of cash the public keeps vs. deposits in banks.
- Reserve Ratio: Cash banks must hold to fulfill customer withdrawals.
- Excess Reserve: Money available for banks to loan out.
Effects of Limiting Money Supply
A country’s money supply impacts interest, inflation, and economic cycles. In the U.S., the Fed implements policies to balance economic growth and inflation. Reducing money supply can temper inflation but risks stymied economic growth and higher unemployment rates.
Money Supply Management by Central Banks
Central banks regulate monetary availability through expansionary or contractionary policies:
- Expansionary Policy: Increasing money supply through actions like purchasing U.S. Treasury bills.
- Contractionary Policy: Decreasing money supply by selling Treasuries.
Difference Between M0, M1, and M2
- M0: Base money including physical currency and central bank reserves.
- M1: M0 plus accessible savings accounts and traveler’s checks.
- M2: M1 plus short-term financial instruments.
The Reason Behind Expansion or Contraction
Economic prosperity increases deposits and lending, enhancing the money supply. Conversely, economic downturns diminish deposits and lending, decreasing the money supply.
Conclusion
The money supply is a fundamental yet comprehensible economic metric, tallying all cash circulating within the U.S. economy. Analyzing this metric involves understanding its use: whether hoarded or spent, invested or utilized for necessities.
The Federal Reserve’s evaluation of the money supply determines necessary actions: augmenting it to boost spending and growth or restricting it to control inflation. The Fed releases its money supply figures on the fourth Tuesday of each month, normally at 1 p.m. Eastern.
References
- The Federal Reserve. “Money Stock Measures - H.6 Release”.
- The Federal Reserve. “Money Stock Measures - H.6 Release”.
- Federal Reserve System. “What Is the Money Supply? Is It Important?”
- Federal Reserve System. “Discontinuance of M3”.
