The amount of money in circulation in an economy. The notion plays an important role in economic theory. Money is used in all transactions, and forms a major part of the wealth of individuals and firms. Monetarists believe that changes in the money supply are important signals of use in economic forecasting, and that the control of the money supply is vital to economic policy. This theory is difficult to apply in practical macroeconomics, as there are several definitions of the money supply in any one country, and modern firms may also hold large balances in foreign currencies.
Money supply ("monetary aggregates", "money stock"), a macroeconomic concept, is the quantity of money available within the economy to purchase goods, services, and securities. Printing on behalf of the Federal Reserve as symbolic tokens of electronic credit-based money that has already been created or more precisely, issued by private banks through fractional reserve banking. However, at present the coin base is held in check and used as a complementary system rather than a competitive system with private bank issue of electronic credit-based money.
The more accurate starting point for the concept of money supply is the total of all electronic credit-based deposit balances in bank (and other financial) accounts (for more precise definitions, see below) plus all the minted coins and printed paper.
The relationship between the M0 and M1 money supplies is the money multiplier — basically, the ratio of cash and coin in people's wallets and bank vaults and ATMs to Total balances in their financial accounts.
Scope
Because (in principle) money is anything that can be used in settlement of a debt, there are varying measures of money supply. The narrowest (i.e., most restrictive) measures count only those forms of money available for immediate transactions, while broader measures include money held as a store of value
United States
The most common measures are named M0 (narrowest), M1, M2, and M3. 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". in circulation with the public and non-bank firms) + private-sector retail bank and building society deposits + Private-sector wholesale bank and building society deposits and CDs.v
Link with inflation
Monetary exchange equation
Money supply is important because it is linked to inflation by the "monetary exchange equation":
where:
velocity = the number of times per year that money changes hands (if it is a number it is always simply nominal GDP / money supply) real GDP = nominal Gross Domestic Product / GDP deflator GDP deflator = measure of inflation. Money supply may be less than or greater than the demand of money in the economyIn other words, if the money supply grows faster than real GDP growth (described as "unproductive debt expansion"), inflation is likely to follow ("inflation is always and everywhere a monetary phenomenon").
The Central Bank
The United States supply of money, outside of coins minted by the United States Mint, can increase only if the private banks issue more by loaning into circulation through Fractional Reserve Bank Lending Practices. Subsequently paper notes are increased only as they are printed by the BEP on behalf of the Federal Reserve Fractional Banking System and are swapped at par value by the Federal Reserve Bank with Private Banks for their already issued electronic credits, which are then expunged (some believe retained) from the system by the Federal Reserve Bank. Of the money in a bank deposit, depending on reserve requirements, either the whole sum or some fraction of it can immediately be lent out. The money supply has just increased, because both the original and secondary deposits count as part of the money supply. The Central Bank injects money from its reserve into the economy by buying a government bond from Bank 1 for $1, Bank 1 lends the proceeds to Person 1, who buys an asset from Person 2, who deposits the proceeds at Bank 2, who loans it to Person 3, who buys a service from Person 4, who deposits the proceeds in Bank 1, and the money supply becomes $3.
Central Bank
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Bank 1
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Person 1
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Person 2
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Bank 2
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Bank reserves at Central Bank
When a central bank is "easing", it triggers an increase in money supply by purchasing government securities on the open market thus increasing available funds for private banks to loan through fractional reserve banking (the issue of new money through loans) and thus grows the money supply. When the central bank is "tightening", it slows the process of private bank issue by selling securities on the open market and pulling money (that could be loaned) out of the private banking sector. It reduces or increases the supply of short term government debt, and inversely increases or reduces the supply of lending funds and thereby the ability of private banks to issue new money through debt.
The operative notion of easy money is that the central bank creates new bank reserves (in the US known as "federal funds"), which let the banks lend out more money. Whatever is not required to be held as reserves is then lent out again, and through the magic of the "money multiplier", loans and bank deposits go up by many times the initial injection of reserves.
However in the 1970s the reserve requirements on deposits started to fall with the emergence of money market funds, which require no reserves.
Arguments and criticism
One of the principal jobs of central banks (such as the Federal Reserve, the Bank of England and the European Central Bank) is to keep money supply growth in line with real GDP growth.
Monetary base (billions of dollars) (not seasonally adjusted)| Monetary Base | |||||
|---|---|---|---|---|---|
| Reserves of depository institutions | 46.4 | ||||
| Reserve balances with F.R. Banks | 13.0 | ||||
| Vault cash surplus | 11.4 | ||||
| Currency | 688.2 | ||||
| Sum | 759.0 | ||||
United States Money Supply
This table shows the United States money supply as reported by the Fed on Sep 30, 2004.
Money Supply (billions of dollars)(not seasonally adjusted)
| M0 (not seasonally adjusted, not adjusted for changes in reserve requirements) | |||||
|---|---|---|---|---|---|
| Currency (The diff between total reserves and the Monetary Base as reported in H.3) | 674.4 | ||||
| Bank's total reserves at the Fed | 46.1 | ||||
| M0 (Monetary Base) | 720.5 | ||||
| M1 | |||||
| Demand Deposits | 321.0 | ||||
| Other Checkable Deposits | 319.5 | ||||
| M1 (Monetary Base) | 1,361.0 | ||||
| M2 | |||||
| Savings deposits | 3,472.5 | ||||
| Small-denomination time deposits | 795.6 | ||||
| Retail money funds | 729.5 | ||||
| M3 | |||||
| Institutional money funds | 1,071.6 | ||||
| Large-denomination time deposits | 1,018.2 | ||||
| Repurchase agreements | 537.3 | ||||
| Eurodollars | 322.2 | ||||
| Sum | 9,311.7 | ||||
| GDP (seasonally adjusted) | 11,643.0 |
|---|---|
| Credit market Debt Outstanding | 35,181.7 |
| Derivatives (notional) | 79,400.0 |
The only deposits that have "reserve requirements" are the M1 "checking deposits".
Controlling money supply by issuing debt
The government can control the growth of M3 through the issuance of new Government debt instruments. (It is critical that we understand that when a bank makes a loan, that is new money and when a loan is paid off that money is destroyed. Only the interest paid on it remains.)
Thus, all debt denominated in dollars -- mortgages, money markets, credit card debt, travelers cheques -- is money. "High powered" money (M0) is created when the elected government spends money into the economy. The money created in the bank loan process is bank money and these two forms of money trade at par one with the other. Banks are limited in the amount of loans they can grant and thus in the amount of bank money (credit) they can create by both the net assets of the bank and by reserve requirements (M0). If additional money is needed in the banking system to allow more loans the Federal Reserve will create money by purchasing Bonds or T-bills with money created from the other.
Perhaps the most obvious way money can be destroyed is if paper bills are burned or taken out of circulation by the central bank.
Current banking systems are based on fractional reserves so money can be destroyed if depositers withdraw funds from a bank. When money is withdrawn it can no longer be used for lending and just as the fractional reserve system gives leverage to the creation of money, it also gives leverage to the destruction of money. Bank savings are actually a kind of loans — savers loan their money to a bank at a low interest rate or merely in exchange for the benefit of convenience or its security (accepting that they lose a small amount of value to inflation). A check written on bank A gets deposited in Bank B and a check written on bank B gets deposited in Bank C and a check on bank C gets deposited in bank A.
Another way money can be destroyed is when any bank loan is paid off or any government bond or T-Bill is purchased by the private sector. In that country many banking reforms were subsequently enacted during the New Deal, including the creation of the Federal Deposit Insurance Corporation to guarantee private bank deposits. ^ http://www.federalreserve.gov/releases/H3/20040930/ ^ http://www.federalreserve.gov/releases/h6/20040930/ ^ Demand deposits at domestically chartered commercial banks, U.S. branches and agencies of foreign banks, and Edge Act Corporations (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float. ^ IRA and Keogh account balances at money market mutual funds are subtracted from retail money funds. ^ Large-denomination time deposits at domestically chartered commercial banks, U.S. branches and agencies of foreign banks, and Edge Act Corporations, excluding those amounts held by depository institutions, the U.S. government, foreign banks and official institutions, and money market mutual funds. ^ RP liabilities of depository institutions, in denominations of $100,000 or more, on U.S. government and federal agency securities, excluding those amounts held by depository institutions, the U.S. government, foreign banks and official institutions, and money market mutual funds. ^ Eurodollars held by U.S. addressees at foreign branches of U.S. banks worldwide and at all banking offices in the United Kingdom and Canada, excluding those amounts held by depository institutions, the U.S. government, foreign banks and official institutions, and by money market mutual funds. ^ http://www.federalreserve.gov/Releases/Z1/Current/accessible/f6.htm ^ http://www.federalreserve.gov/Releases/Z1/Current/accessible/l1.htm ^ http://www.occ.treas.gov/deriv/deriv.htm ^ http://www.federalreserve.gov/releases/h6/discm3.htm ^ https://research.stlouisfed.org/fred2/data/M3.txt ^ http://news.yahoo.com/s/cpress/20060317/ca_pr_on_wo/us_deeper_in_debt ^ http://www.ecb.int/home/html/index.en.html
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