Understanding the amount of money circulating in the economy, often referred to as the money supply, is crucial for grasping basic economics. The money supply isn’t just about the physical cash in your wallet; it’s the total stock of safe assets that households and businesses use for transactions and short-term savings. This includes cash, coins, and, importantly, the balances held in various bank accounts.
To get a clearer picture, economists categorize the money supply into different measures. Here are a few key ones:
The Monetary Base: Think of this as the foundation of the money supply. It’s the total of currency in circulation – the physical cash held by the public – plus the reserve balances that commercial banks hold at the Federal Reserve. These reserves are deposits banks keep at the Fed or as vault cash to meet regulatory requirements and manage liquidity.
M1: This is a narrower measure of money supply focusing on the most liquid forms of money. M1 includes all currency held by the public and transaction deposits. Transaction deposits are funds in accounts that can be easily used for payments, primarily checking accounts. M1 essentially represents money that is readily available for spending.
M2: M2 is a broader measure, encompassing M1 and some less liquid, but still easily accessible, assets. It adds to M1 things like savings accounts, small-denomination time deposits (certificates of deposit under $100,000), and retail money market mutual fund shares. M2 represents money that is quickly convertible to cash or checking account balances.
The Federal Reserve System meticulously tracks and reports on these money supply measures. You can find detailed data in their H.6 statistical release, known as “Money Stock Measures.”
Why is understanding the amount of money circulating in the economy important? Because changes in the money supply can have significant effects on the economy. Historically, there have been periods where the growth of the money supply has been closely linked to economic indicators like nominal gross domestic product (GDP) and the overall price level, or inflation.
While the relationship isn’t always direct or predictable, the Federal Open Market Committee (FOMC), the body within the Federal Reserve that sets monetary policy, does consider money supply data. However, it’s just one piece of a much larger puzzle. Policymakers analyze a wide range of economic and financial data to make informed decisions aimed at maintaining stable prices and full employment.
For those interested in delving deeper, the Federal Reserve offers a wealth of statistics and historical data on various economic topics, including the money supply.
