What is Money Supply and How is it Measured?

What is Money Supply?

Money supply encompasses all forms of currency issued and other liquidity instruments in an economy of a country, measured at a specific point in time.

Thus, money supply includes cash, coins circulating in the economy, along with bank deposits, checks, and various easily convertible documents.

The money supply can be controlled by the Central Bank through monetary policy instruments.

How is Money Supply Allocated to the Economy?

If goods are distributed from the primary source (manufacturers) to agents, retailers, and ultimately consumers, so is money. As you know, the Central Bank is the sole authority in issuing currency of a country or territory, so the Central Bank is the primary source of money, which is then distributed first through commercial banks, and then from commercial banks to businesses and individuals.

What is Money Supply and How is it Measured?

How is Money Supply Measured?

Based on liquidity, money is divided into the following types:

  • M0: Includes all cash or coins issued by the Central Bank and circulating in the country or territory it oversees. It’s worth noting that cash deposited in banking systems is not considered cash circulating in the economy, so it’s not counted in M0. Since M0 can easily change just by depositing or withdrawing cash, it’s rarely used to calculate money supply.
  • M1 (Transactions Money): Includes all cash circulating plus demand deposits, checking accounts, and checks. The common feature of these types is that they can all be easily used for transactions and easily converted into cash.
  • M2 (Broad Money): Includes M1 plus time deposits in banks such as savings accounts or money market accounts, certificates of deposit (CDs), and some other near-cash assets. These types have high liquidity but not as high as M1, as with savings accounts, you can only withdraw or deposit at certain times.

There are also broader measurement methods, such as M3 including M2 and some short-term bonds, or some countries using both M4 and more. However, each country currently defines their M0, M1, M2, etc., in different ways, making it difficult to reflect the consistency of global money supply measurement. Typically, the two indices used to measure a country’s money supply are M1 and M2.

According to the latest data in August 2020, the US money supply M1 and M2 were valued at 5.4 trillion USD and 18.4 trillion USD, respectively. These numbers have increased significantly in 2020 due to the impact of the COVID-19 pandemic, as the Fed has injected a large amount of money into the market to stimulate the economy.

How does Money Supply Impact a Country’s Economy?

When the Central Bank implements monetary easing measures, the money supply increases, which partially leads to a decrease in interest rates, causing people to tend to borrow more rather than save, leading to increased consumer demand and economic growth. However, excessive total demand may lead to inflation. Conversely, when the Central Bank tightens monetary policy, the money supply decreases, leading to an increase in interest rates, restraining economic growth and reducing inflation.