Money Supply
Candlefocus EditorThe money supply is the measure of the amount of money, liquidity and credit available within an economy. It is an important indication of economic strength, since it shows how much money is available to finance activities and investments, and to fund consumer activity.
The money supply is also one of the primary tools used by central banks to influence economic activity. Central banks strive to maintain a healthy balance in the money supply, as too much or too little money can be detrimental to the economy.
The three most commonly used measures of money supply include M1 (currency and demand deposits), M2 (M1 plus near money) and M3 (M2 plus large time deposits and institutional money market funds).
M1 includes currency, such as coins and bills, plus all accounts that businesses and individuals can access instantly without restrictions (i.e. demand deposits). M2 includes M1 plus savings deposits, money market mutual funds and some other near deposits. M3 is the largest measure, and includes M2 plus large time deposits and institutional money market funds.
The Federal Reserve's Open Market Committee (FOMC) is responsible for influencing the money supply. To increase the money supply, the FOMC increases the reserve requirements or lowers reserve rates, which allows banks to lend more money. To reduce the money supply, the FOMC raises the reserve requirements or increases reserve rates, reducing the amount of money that can be lent.
Monetarists believe that increasing the money supply will lead to inflation, as the availability of money increases prices along with it. Therefore, they believe that increasing the money supply should be done carefully and with caution. On the other hand, Keynesians believe that increasing the money supply can lead to economic growth, as long as it is done in conjunction with other stimulative measures.
All in all, it is important to maintain an appropriate balance in the money supply in order to have a healthy and prosperous economy. The FOMC’s decisions are made with this in mind and have far-reaching consequences for the entire global economy.