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The tone or style of this article or section may not be appropriate for Wikipedia. Specific concerns may be found on the talk page. See Wikipedia\'s guide to writing better articles for suggestions.(August 2007) |
Money supply, also known as monetary aggregateshttp://financial-dictionary.thefreedictionary.com/Monetary+aggregate and money stockhttp://www.auburn.edu/~johnspm/gloss/money_stock, is the entire quantity of bills, coins, loans, credit and other liquid instruments in a country\'s economyhttp://www.investopedia.com/terms/m/moneysupply.asp. The term "money supply" can refer to any supply of money, but the most common usage of the term is to describe the money supply of a nationhttp://www.google.com/search?q=money+supply using the money supply statistics recorded and published by the government.
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Money supply data is recorded and published in order to monitor the growth of the money supply. Public- and private-sector analysts have long monitored this growth because of the effects that it is believed to have on real economic activity and on the price levelhttp://www.newyorkfed.org/aboutthefed/fedpoint/fed49.html. The money supply is considered an important instrument for controlling inflation by those economists who say that growth in money supply will only lead to inflation if money demand is stablehttp://www.investorwords.com/3110/money_supply.html.
Because (in principle) money is anything that can be used in settlement of a debt, there are varying measures of 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 that type of money. Narrow money is the type of money that is more easily effected by monetary policy whereas broad money is more difficult to affect through monetary policy. Narrow money exists in smaller quantities while broad money exists in much larger quantities. Each type of money can be classified by placing it along a spectrum between narrow (easily effected) and broad (difficult to effect) money. The different types of money are typically classified as M\'s. The number of M\'s usually range from M0 (most narrow) to M3 (broadest) but which M\'s are actually used depends on the system. The typical layout for each of the M\'s is as follows:
The different forms of money in government money supply statisitics arise from the practice of fractional-reserve banking. Whenever a bank gives out a loan in a fractional-reserve banking system, a new type 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 systemBank for International Settlements - The Role of Central Bank Money in Payment Systems. See page 9, titled, "The coexistence of central and commercial bank monies: multiple issuers, one currency": http://www.bis.org/publ/cpss55.pdf A quick quote in reference to the 2 different types of money is listed on page 3. It is the first sentence of the document:
http://www.ecb.int/press/key/date/2000/html/sp001109_2.en.html One quote from the article referencing the two types of money:
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.
Year-on-year change in the components of the US money supply 1960-2007
Currency component of the U.S. money supply 1959-2007
The Federal Reserve previously published data on three monetary aggregates, but now it only publishes data on 2 of them. The first, M1, is made up of types of money commonly used for payment, basically currency (M0) and checking deposits. The second, M2, includes M1 plus balances that generally are similar to transaction accounts and that, for the most part, can be converted fairly readily to M1 with little or no loss of principal. The M2 measure is thought to be held primarily by households. The third aggregate, M3, which is no longer published, included M2 plus certain accounts that are held by entities other than individuals and are issued by banks and thrift institutions to augment M2-type balances in meeting credit demands; it also includes balances in money market mutual funds held by institutional investors. The aggregates have had different roles in monetary policy as their reliability as guides has changed. The following details their principal componentsebook: The Federal Reserve - Purposes and Functions:http://www.federalreserve.gov/pf/pf.htm:
The Federal Reserve ceased publishing M3 statistics in March 2006, explaining that M3 did not appear to convey additional information about economic activity compared to M2, had not been used in determining economic policy, and that the costs to collect M3 data outweighed the benefits. Some of the data used to calculate M3 are still collected and published on a regular basis.Discontinuance of M3
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It has been suggested that M4 money supply be merged into this article or section. (Discuss) |
M4 money supply of the 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".
The European Central Bank\'s definition of euro area monetary aggregatesThe ECB\'s definition of euro area monetary aggregates: http://www.ecb.int/stats/money/aggregates/aggr/html/hist.en.html:
The Reserve Bank of Australia defines the monetary aggregates ashttp://www.rba.gov.au/Glossary/text_only.asp:
The Reserve Bank of New Zealand defines the monetary aggregates ashttp://www.rbnz.govt.nz/statistics/monfin/c3/description.html:
Money supply is important because it is linked to inflation by the "monetary exchange equation":
\textrm{velocity} \times \textrm{money\ supply} = \textrm{real\ GDP} \times \textrm{GDP\ deflator}
U.S. M3 money supply as a proportion of gross domestic product.
where:
In 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"). This statement must be qualified slightly, due to changes in velocity. While the monetarists presume that velocity is relatively stable, in fact velocity exhibits variability at business-cycle frequencies, so that the velocity equation is not particularly useful as a short run tool. Moreover, in the US, velocity has grown at an average of slightly more than 1% a year between 1959 and 2005 (which is to be expected due to the increase in population, unless money supply grows very rapidly).
Another aspect of money supply growth that has come under discussion since the collapse of the housing bubble in 2007 is the notion of "asset classes." Economists have noted that M3 growth may not affect all assets equally. For example, following the stock market runup and then decline in 2001, home prices began an historically unusual climb that then dropped sharply in 2007. The dilemma for the Federal Reserve in regulating the money supply is that lowering interest rates to shore up price declines in one asset class, like real estate, may cause prices in other asset classes to rise.
In terms of percentage changes (to a small approximation, the percentage change in a product, say XY is equal to the sum of the percentage changes %X + %Y). So:
That equation rearranged gives the "basic inflation identity":
Inflation (%P) is equal to the rate of money growth (%M), plus the change in velocity (%V), minus the rate of output growth (%Y)."Breaking Monetary Policy into Pieces", May 24 2004, http://www.hussmanfunds.com/wmc/wmc040524.htm
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The examples and perspective in this article or section may not represent a worldwide view of the subject. Please improve this article or discuss the issue on the talk page. |
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. Note that while the terms "easing" and "tightening" are commonly used to describe the central bank\'s stated interest rate policy, a central bank has the ability to influence the money supply in a much more direct fashion, as explained earlier in this paragraph.
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. These loans get spent, and the proceeds get deposited at other banks. Whatever is not required to be held as reserves is then lent out again, and through the "multiplying" effect of the fractional-reserve system, 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. Then in the early 1990s, reserve requirements were dropped to zero on savings deposits, CDs, and Eurodollar deposit. At present, reserve requirements apply only to "transactions deposits" – essentially checking accounts. The vast majority of funding sources used by private banks to create loans are not limited by bank reserves. Most commercial and industrial loans are financed by issuing large denomination CDs. Money market deposits are largely used to lend to corporations who issue commercial paper. Consumer loans are also made using savings deposits which are not subject to reserve requirements. These loans can be bunched into securities and sold to somebody else, taking them off of the bank\'s books.
Therefore, neither commercial nor consumer loans are any longer limited by bank reserves. Since 1995, the volume of such loans has exploded, while bank reserves have declined.[citation needed]
In recent years, the irrelevance of open market operations has also been argued by academic economists renown for their work on the implications of rational expectations, including Robert Lucas, Jr., Thomas Sargent, Neil Wallace, Finn E. Kydland, Edward C. Prescott and Scott Freeman.
Assuming that prices do not instantly adjust to equate supply and demand, one of the principal jobs of central banks is to ensure that aggregate (or overall) demand matches the potential supply of an economy. Central banks can do this because overall demand can be controlled by the money supply. By putting more money into circulation, the central bank can stimulate demand. By taking money out of circulation, the central bank can reduce demand.
For instance, if there is an overall shortfall of demand relative to supply (that is, a given economy can potentially produce more goods than consumers wish to buy) then some resources in the economy will be unemployed (i.e., there will be a recession). In this case the central bank can stimulate demand by increasing the money supply. In theory the extra demand will then lead to job creation for the unemployed resources (people, machines, land), leading back to full employment (more precisely, back to the natural rate of unemployment, which is basically determined by the amount of government regulation and is different in different countries).
However, central banks have a difficult balancing act because, if they put too much money into circulation, demand will outstrip an economy\'s ability to supply so that, even when all resources are employed, demand still cannot be satisfied. In this case, unemployment will fall back to the natural rate and there will then be competition for the last remaining labour, leading to wage rises and inflation. This can then lead to another recession as the central bank takes money out of circulation (raising interest rates in the process) to try to damp down demand.
The main debate amongst economists in the second half of the twentieth century concerned the central banks ability to know how much money to inject into or take out of circulation under different circumstances. Some economists like Milton Friedman believed that the central bank would always get it wrong, leading to wider swings in the economy than if it were just left alone. That is why they advocated a non-interventionist approach.
Current Chairman of the U.S. Federal Reserve, Ben Bernanke, has suggested that over the last 10 to 15 years, many modern central banks have become relatively adept at manipulation of the money supply, leading to a smoother business cycle, with recessions tending to be smaller and less frequent than in earlier decades, a phenomenon he terms "The Great Moderation" http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/default.htm.
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