What is the money supply? Is it important?
The money supply is the total amount of money—cash, coins, and balances in bank accounts—in circulation.
The money supply is commonly defined to be a group of safe assets that households and businesses can use to make payments or to hold as short-term investments. For example, U.S. currency and balances held in checking accounts and savings accounts are included in many measures of the money supply.
There are several standard measures of the money supply, including the monetary base, M1, and M2.
- The monetary base: the sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve).
- M1: the sum of currency held by the public and transaction deposits (inclusive of currency held by the public and transaction deposits—a category that includes balances held in checking accounts and other very liquid deposits) at depository institutions (which are financial institutions that obtain their funds mainly through deposits from the public, such as commercial banks, savings and loan associations, savings banks, and credit unions).
- M2: M1 plus small-denomination time deposits (those issued in amounts of less than $100,000) and retail money market mutual fund shares.
Data on money supply are reported in the Federal Reserve's H.6 statistical release ("Money Stock Measures").
Over some periods, measures of the money supply have exhibited fairly close relationships with important economic variables such as nominal gross domestic product (GDP) and the price level. The Federal Open Market Committee, the monetary policymaking body of the Federal Reserve System, still regularly reviews money supply data in conducting monetary policy, but money supply figures are just part of a wide array of financial and economic data that policymakers review.
Related Information
Statistics & Historical Data
FAQs
The money supply is the total amount of money—cash, coins, and balances in bank accounts—in circulation. The money supply is commonly defined to be a group of safe assets that households and businesses can use to make payments or to hold as short-term investments.
What is the money supply and why is it important? ›
To summarize, the money supply is important because if the money supply grows at a faster rate than the economy's ability to produce goods and services, then inflation will result. Also, a money supply that does not grow fast enough can lead to decreases in production, leading to increases in unemployment.
Is the most important measure of money supply? ›
In India, M3 is the most commonly used measure of money supply. Q. What are the components of money supply?
Why is it important to regulate the supply of money? ›
To ensure a nation's economy remains healthy, its central bank regulates the amount of money in circulation. Influencing interest rates, printing money, and setting bank reserve requirements are all tools central banks use to control the money supply.
What is the function of the supply of money? ›
The money supply economics is associated with the government's direct power as it is the government that issues currency either in paper form or in the form of a coin as a combination of treasuries bills and demand drafts of banks.
Who controls the money supply and why? ›
The Federal Reserve System manages the money supply in three ways: Reserve ratios. Banks are required to maintain a certain proportion of their deposits as a "reserve" against potential withdrawals. By varying this amount, called the reserve ratio, the Fed controls the quantity of money in circulation.
What happens if the money supply grows too slowly? ›
If the supply of money grows too quickly, it can cause inflation, which is a general rise in all prices. If the supply of money grows too slowly, it can cause recession, which is a decline of goods and ser- vices produced.
What are 3 major measures of the money supply? ›
M1 consists of coins and currency, checking accounts and traveler's checks. M2 is a more broad definition of money. M2 = M1 + small savings accounts, money market funds and small time deposits. M3 is even more broad and includes M2 + large time deposits, large money market funds and repurchase agreements.
Who backs the US money supply? ›
Government backs the money supply.
In the United States, the money supply is backed up by the government, which guarantees to keep the value of the money supply relatively stable.
How can we control the money supply? ›
By adjusting the CRR, the RBI can control the money banks have available for lending. Lowering the CRR increases the money available for lending while raising it reduces the money supply. Repo Rate and Reverse Repo Rate: These are interest rates at which banks can borrow money from the RBI.
The Bottom Line
Today, the Fed uses its tools to control the supply of money to help stabilize the economy. When the economy is slumping, the Fed increases the supply of money to spur growth. Conversely, when inflation is threatening, the Fed reduces the risk by shrinking the supply.
What happens when too little money is in circulation? ›
Its economists track the money supply over time in order to determine whether too much money is flowing, which can lead to inflation, or too little money is flowing, which can cause deflation.
Does buying bonds increase money supply? ›
If the central bank wants interest rates to be lower, it buys bonds. Buying bonds injects money into the money market, increasing the money supply. When the central bank wants interest rates to be higher, it sells off bonds, pulling money out of the money market and decreasing the money supply.
Why is money supply important? ›
Why Is the Money Supply Important? Because money is used in virtually all economic transactions, it has a powerful effect on economic activity.
Which is the primary function of money supply? ›
One of the primary functions of money is as a medium of exchange as it can be used for any or all transactions wherein goods or services are purchased or sold. Therefore, one can buy or sell products in exchange for money.
What is the main component of money supply? ›
Demand deposits are by far the most important component of money supply. In case of demand deposits, the bank agrees to pay money on demand at any time to whomsoever the owner of the deposit may wish.
What is the money supply for dummies? ›
What Is the Money Supply? The money supply is the sum total of all of the currency and other liquid assets in a country's economy on the date measured. The money supply includes all cash in circulation and all bank deposits that the account holder can easily convert to cash.
Why is it important that the Fed control the money supply? ›
The Bottom Line
Today, the Fed uses its tools to control the supply of money to help stabilize the economy. When the economy is slumping, the Fed increases the supply of money to spur growth. Conversely, when inflation is threatening, the Fed reduces the risk by shrinking the supply.
Does increasing money supply increase interest rates? ›
What Is the Connection Between the Money Supply and Interest Rates? A nation's money supply and interest rates have an inverse relationship. Interest rates should be lower if there's a higher supply of money in a country's economy. Rates should be higher if the money supply is lower.
