In macroeconomics, money supply (or money stock) refers to the total volume of money held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circulation (i.e. physical cash) and demand deposits (depositors' easily accessed assets on the books of financial institutions).Alan Deardorff. "Money supply," Deardorff's Glossary of International EconomicsKarl Brunner, "money supply," The New Palgrave: A Dictionary of Economics, v. 3, p. 527. Money supply data is recorded and published, usually by the national statistical agency or the central bank of the country. Empirical money supply measures are usually named M1, M2, M3, etc., according to how wide a definition of money they embrace. The precise definitions vary from country to country, in part depending on national financial institutional traditions.
Even for narrow aggregates like M1, by far the largest part of the money supply consists of deposits in commercial banks, whereas currency (banknotes and coins) issued by central banks only makes up a small part of the total money supply in modern economies. The public's demand for currency and bank deposits and commercial banks' supply of loans are consequently important determinants of money supply changes. As these decisions are influenced by central banks' monetary policy, not least their setting of interest rates, the money supply is ultimately determined by complex interactions between non-banks, commercial banks and central banks.
According to the quantity theory supported by the monetarist school of thought, there is a tight causal connection between growth in the money supply and inflation. In particular during the 1970s and 1980s this idea was influential, and several major central banks during that period attempted to control the money supply closely, following a monetary policy target of increasing the money supply stably.
Consequently, the money supply has lost its central role in monetary policy, and central banks today generally do not try to control the money supply. Instead they focus on adjusting interest rates, in developed countries normally as part of a direct inflation target which leaves little room for a special emphasis on the money supply. Money supply measures may still play a role in monetary policy, however, as one of many economic indicators that central bankers monitor to judge likely future movements in central variables like employment and inflation.
Measures of money supply
There are several standard measures of the money supply, classified along a spectrum or continuum between narrow and broad monetary aggregates. Narrow measures include only the most liquid assets: those most easily used to spend (currency, checkable deposits). Broader measures add less liquid types of assets (certificates of deposit, etc.).
This continuum corresponds to the way that different types of money are more or less controlled by monetary policy. Narrow measures include those more directly affected and controlled by monetary policy, whereas broader measures are less closely related to monetary-policy actions.
The different types of money are typically classified as "M"s. The "M"s usually range from M0 (narrowest) to M3 (and M4 in some countries) (broadest), but which "M"s, if any, are actually focused on in central bank communications depends on the particular institution. A typical layout for each of the "M"s is as follows for the United States:
Type of money M0 MB M1 M2 M3 MZM Notes and coins in circulation (outside Federal Reserve Banks and the vaults of depository institutions) (currency) ✓. DollarDaze Economic Commentary Blog by Mike Hewitt. ✓ ✓ ✓ ✓ ✓ Notes and coins in bank vaults (vault cash) ✓ Federal Reserve Bank credit (required reserves and excess reserves not physically present in banks) ✓ Traveler's checks of non-bank issuers ✓ ✓ ✓ ✓ Demand deposits ✓ ✓ ✓ ✓ Other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts. ✓M1 Money Stock (M1) – FRED – St. Louis Fed. Research.stlouisfed.org. ✓ ✓ ✓ Savings deposits✓ ✓ ✓ ✓ Time deposits less than $100,000 and retail money market funds, for individual investors ✓ ✓Large time deposits, institutional money market funds, short-term repurchase and other larger liquid assetsM3 Definition. Investopedia (February 15, 2009). ✓All money market funds ✓ : In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.M0 (monetary base). Moneyterms.co.uk. : 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. : Bank reserves are not included in M1. : Represents M1 and "close substitutes" for M1. M2 is a broader classification of money than M1. : M2 plus large and long-term deposits. : Money with zero maturity. It measures the supply of financial assets redeemable at par on demand.
Creation of money
Both central banks and commercial banks play a role in the process of money creation. In short, in the fractional-reserve banking system used throughout the world, money can be subdivided into two types:
central bank money – obligations of a central bank, including currency and central bank depository accounts commercial bank money – obligations of commercial banks, including checking accounts and savings accounts.
In the money supply statistics, central bank money is MB while the commercial bank money is divided up into the M1–M3 components, where it makes up the non-M0 component.
By far the largest part of the money used by individuals and firms to execute economic actions are commercial bank money, i.e. deposits issued by banks and other financial institutions. In the United Kingdom, deposit money outweighs the central bank issued currency by a factor of more than 30 to 1. In the United States, where the country's currency has a special international role being used in many transactions around the world, legally as well as illegally, the ratio is still more than 8 to 1. Commercial banks create money whenever they make a loan and simultaneously create a matching deposit in the borrower's bank account. In return, money is destroyed when the borrower pays back the principal on the loan. Movements in the money supply therefore to a large extent depend on the decisions of commercial banks to supply loans and consequently deposits, and the public's behavior in demanding currency as well as bank deposits. These decisions are influenced by the monetary policy of central banks, so that money supply is ultimately created by complex interactions between banks, non-banks and central banks.
Even though central banks today rarely try to control the amount of money in circulation, their policies still impact the actions of both commercial banks and their customers. When setting the interest rate on central bank reserves, interest rates on bank loans are affected, which in turn affects their demand. Central banks may also affect the money supply more directly by engaging in various open market operations. They can increase the money supply by purchasing government securities, such as government bonds or treasury bills. This increases the liquidity in the banking system by converting the illiquid securities of commercial banks into liquid deposits at the central bank. This also causes the price of such securities to rise due to the increased demand, and interest rates to fall. In contrast, when the central bank "tightens" the money supply, it sells securities on the open market, drawing liquid funds out of the banking system. The prices of such securities fall as supply is increased, and interest rates rise.
In some economics textbooks, the supply-demand equilibrium in the markets for money and reserves is represented by a simple so-called money multiplier relationship between the monetary base of the central bank and the resulting money supply including commercial bank deposits. This is a short-hand simplification which disregards several other factors determining commercial banks' reserve-to-deposit ratios and the public's money demand.
National definitions of "money" East Asia Hong Kong
The Hong Kong Basic Law and the Sino-British Joint Declaration provides that Hong Kong retains full autonomy with respect to currency issuance. Currency in Hong Kong is issued by the government and three local banks under the supervision of the territory's de facto central bank, the Hong Kong Monetary Authority. Bank notes are printed by Hong Kong Note Printing.
A bank can issue a Hong Kong dollar only if it has the equivalent exchange in US dollars on deposit. The currency board system ensures that Hong Kong's entire monetary base is backed with US dollars at the linked exchange rate. The resources for the backing are kept in Hong Kong's exchange fund, which is among the largest official reserves in the world. Hong Kong also has huge deposits of US dollars, with official foreign currency reserves of 331.3 billion USD . Currency peg history
Hong Kong's exchange rate regime has changed over time. 1967: Sterling was devalued, the peg was increased from 1 shilling 3 pence (£1 = HK$16) to 1 shilling 4½ pence (£1 = HK$14.5455). Valued in USD, the currency went from US$1 = HK$5.71 to US$1 = HK$6.06 1972: pegged to the US dollar, US$1 = HK$5.65 1973: US$1 = HK$5.085 1974 to 1983: The Hong Kong dollar was floated October 17, 1983: Pegged at US$1 = HK$7.80 through the currency board system May 18, 2005: A lower and upper guaranteed limit are in place at 7.75 to the US dollar. Lower limit was lowered from 7.80 to 7.85, between May 23 and June 20, 2005. The Monetary Authority indicated this was to narrow the gap between interest rates between Hong Kong and the US, and to avoid the HK dollar being used as a proxy for speculative bets on a renminbi revaluation.
Japan
The Bank of Japan defines the monetary aggregates as: M1: cash currency in circulation, plus deposit money M2 + CDs: M1 plus quasi-money and CDs M3 + CDs: M2 + CDs plus deposits of post offices; other savings and deposits with financial institutions; and money trusts Broadly defined liquidity: M3 and CDs, plus money market, pecuniary trusts other than money trusts, investment trusts, bank debentures, commercial paper issued by financial institutions, repurchase agreements and securities lending with cash collateral, government bonds and foreign bonds
Europe Eurozone
The European Central Bank's definition of euro area monetary aggregates: M1: Currency in circulation plus 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 United Kingdom
There are just two official UK measures. M0 is referred to as the "wide monetary base" or "narrow money" and M4 is referred to as "broad money" or simply "the money supply". M0: Notes and coin in circulation plus banks' reserve balance with Bank of England. (When the bank introduced Money Market Reform in May 2006, the bank ceased publication of M0 and instead began publishing series for reserve balances at the Bank of England to accompany notes and coin in circulation.) M4: Cash outside banks (i.e. in circulation with the public and non-bank firms) plus private-sector retail bank and building society deposits plus private-sector wholesale bank and building society deposits and certificates of deposit. In 2010 the total money supply (M4) measure in the UK was £2.2 trillion while the actual notes and coins in circulation totalled only £47 billion, 2.1% of the actual money supply.