Money Supply

Money Supply explained

The money supply is of great economic importance. Changes in the growth rate of the money supply influence employment, interest rates, prices and production volume. Economists examine the money supply and implement monetary policies changing the volume of currency in circulation. It is done as rapid growth of the money supply can lead to inflation and monetary restraint – to deflation. 

The impact on the economy

The increase in the money supply arises due to the militarization of the economy, credit expansion, and foreign currency inflow. It usually results in the decline in interest rates. When banks cut an interest rate at which consumers pay back the loans, it leads to a consumer spending growth, as borrowed money becomes more available for them. When there is an economic slowdown in the country, the government can increase the money supply in order to stimulate consumer spending.

Under such conditions manufacturers tend to buy more raw materials and increase production volume. It usually pushes the employment rate. 

A decrease in the money supply leads to the opposite consequences. For example, the central bank can raise interest rates or tighten loan conditions.

It was assumed for a long time that change in the amount of the money supply influenced macroeconomic performance and business cycles. Besides, the increase in the money supply was associated with the activation of inflationary processes and expectations. Nevertheless, since 2000, it has raised many doubts. As a consequence, the correlation between two economic terms stopped being a guide for monetary policy.

Methods of measuring Money Supply

The monetary aggregates M0, M1, M2 and M3 are used to analyze the structure of the money supply. These indicators are calculated and published by central banks of various countries. Each country can make changes to the criteria of a particular monetary aggregate. Monetary aggregates are types of money that differ from each other in the degree of liquidity.

For instance, M1 includes cash and coins outside the banks, traveler's checks, demand deposits and other check deposits. M2 consists of M1, various savings accounts, including money market accounts, retail money market funds, as well as fixed deposits with a nominal value of less than 100 thousand dollars. M3 includes M2, all other savings certificates and deposits, as well as Eurodollar deposits and REPO agreements.

The government or central bank usually informs citizens on the amount of the money supply. The Federal Reserve of the U.S. reports on the components of M1 and M2 every week and month.