The Money Supply
The term itself implies that a certain amount of money exists at any given time, even though the quantity
may be unknown. In truth there can be no meaningful measure of the quantity because it is continually varying as a function
of demand. The Federal Reserve defines money as anything that serves all of the following:
* Medium of exchange: is accepted as payment for goods and services (and debts).
* Store of value: can be held for future purchases.
* Standard of value: serves as a yardstick for measuring the prices of goods and services.
Because money is used in virtually all economic transactions, it has a powerful effect on economic activity.
An increase in the supply of money puts more money in the hands of consumers, thus stimulating increased spending. The spread
of business activity increased the demand for labor and raises the demand for capital goods. If the money supply continues
to expand, prices begin to rise and the public can expect inflation. When the supply of money falls, or when its rate of growth
declines the opposite effects occur, economic activity declines and either disinflation (reduced inflation) or deflation (falling
prices) results.
Federal Reserve policy is the most important determination of the money supply. The Federal Reserve affects
the money supply by affecting its most important component, bank deposits. The Federal Reserve requires commercial banks and
other financial institutions to hold as a reserve a fraction of the deposits they accept. The Federal Reserve controls reserves
by lending money to the banks and changing the
The Federal Reserve uses open-market operations to either increase or decrease
reserves.
M1: Cash and Transactions
Several different measures of money have been developed to accommodate the diversity of bank accounts and
other payment mechanisms. The narrowest definition of the money supply is designated M1, which includes:
* Currency in circulation
* Transactions account balances
* Traveler
s checks
M1 is a measure of total money supply. The M1 money supply includes only checkable demand deposits. The largest
component of M1 is transactions account balances, which are balances in bank accounts that are readily accessed by check.
This includes:
* Checking accounts
* NOW accounts
* ATS accounts
* Credit union share draft
* Demand deposits at mutual savings banks
The distinguishing features of all transactions accounts is that they permit a direct payment to a third party
(by check or debit card), without requiring a trip to the bank to make a special withdrawal.
M2: M1 + Savings accounts, etc.
Since people can and do dip into there savings accounts on occasion, savings account balances are almost as
good a substitute for cash as transactions accounts balances.
Additional measures of the money supply have been constructed to account for the possibility of using savings
accounts, money market mutual funds, and various other deposits to finance everyday spending. The most widely watched measure
is M2. M2 includes:
* Everything in M1
* Various savings account types
* Money market accounts
* Certificate of deposit accounts of under $100,000
The money market is a general term for the markets in which banks lend to and borrow money from each other,
trade financial instruments such as certificate of deposits or enter agreements such as repos (repurchase agreement) and reverses.
The market normally trades in maturities up to one year. It provides short to medium term liquidity in the global financial
system.
M3: Other Deposits
The M3 money supply is a broad measure of money and is an estimate of the entire supply of money within an
economy. The M3 money supply includes:
* Everything in M2
* All other certificate of deposits
* Deposits of euros
* Repurchase agreements
Measures of the money supply are intended to gauge the extent of purchasing power held by consumers. But the
extent of purchasing power depends on how accessible assets are and how often people use them. The various money supply measures
reflect variations in the liquidity and accessibility of assets
