International Finance Theory and Policy
by Steven M. Suranovic
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Finance 40-4
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Money Supply MeasuresIn the US, the Federal Reserve Bank reports several distinct measures of the aggregate money supply. The narrowest measure, M1, includes only the most liquid assets. Higher numbers following an "M" reflect broader measures of money that include less liquid assets. Below is a description of M1 - M3. However, unless otherwise specified all later references to the money supply will relate to the M1 definition. The Money Supply Measure "M1" M1 consists of the most highly liquid assets. That is, M1 includes all forms of assets that are easily exchangeable as payment for goods and services. It consists of coin and currency in circulation, traveler's checks, demand deposits, and other checkable deposits. The first item in M1 is currency and coin in circulation. In the US, currency refers to $1, $5, $10, $20, $50 and $1000 bills. Coin refers to pennies, nickels, dimes, etc. In circulation, means that it has to be outside of banks, in people's and businesses wallets and purses and cash registers. Once the currency or coin is deposited in a bank, it is no longer considered to be in circulation, thus it is no longer a part of the M1 money supply. The second item of M1 is traveler's checks. Traveler's checks are like currency, except that the have a form of insurance tied to them. If a traveler's check is lost or stolen, the issuer will reimburse you for the loss. The third item in M1 is demand deposits or checking account balances in banks. These consist of money individuals and businesses have deposited into an account in which a check can be written to pay for goods and services. When a check is presented to the bank, it represents a demand for transfer of funds from the check writer to the agent receiving the check. Since the funds must be disbursed upon demand, we also refer to these as demand deposit. The final category in M1 is labeled, "other checkable deposits." This consists of two items; NOW accounts and ATS accounts. NOW stands for "negotiable orders of withdrawal." A NOW account is exactly like a checking account except for one thing, it can earn interest. Thus, checking accounts without interest are demand deposits, those with interest are NOW accounts. ATS stands for "automatic transfer service." ATS accounts are savings accounts (also called time deposits) with one special feature. They can be drawn upon automatically to cover overdrafts from one's checking account. Thus, if an individual has a checking account with "overdraft protection" tied to their savings account, then the savings account is an ATS account. The following table shows the M1 money supply for the US economy as of January 2005. Notice that the largest component of M1, just over half, is the coin and currency in circulation. Traveler's checks are an insignificant share at $7.5 billion. Demand deposits and other checkable deposits almost equally split the remaining shares of M1 at close to 25% each. The total value of the M1 money supply is $1,353 billion, which is near 10% of annual US GDP.
M2 is a broader measure of money than M1. It includes all of M1, the most liquid assets, and a collection of additional assets that are slightly less liquid. These additional assets include savings accounts, money market deposit accounts, small time deposits (less than $100,000) (these would include certificates of deposits) and retail money market mutual funds. Excluded are IRA and Keogh deposits in money market accounts. (These are excluded since they are retirement funds and hence are unlikely to be used as payment for goods and services anytime in the near future) The Money Supply Measure "M3" M3 is an even broader definition of the money supply, including M2 and other assets even less liquid than M2. As the number gets larger, 1 … 2 … 3, the assets included become less and less liquid. The additional assets include large-denomination time deposits (amounts greater than $100,000), balances in institutional money funds, (these include pension funds deposits), RP liabilities issued by depository institutions (refers to repurchase agreements), and Eurodollars held by US residents at foreign branches of US banks worldwide and all banking offices in Canada and the UK (eurodollars are any US dollar deposits made in a depository institution outside the US). M3 excludes assets held by depository institutions, the US government, money funds, and foreign banks and official institutions.
International Finance Theory and Policy - Chapter 40-4: Last Updated on 2/18/05
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