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Money supply

Money supply, a macroeconomic concept, is the quantity of money available within the economy to purchase goods and services[?]. Because (in principle) money is anything that can be used in settlement of a debt, there are varying measures of money supply. The narrowest (ie. more restrictive) measures count only those forms of money held for immediate transactions.

Broader measures include money held as a store of value. Different measures of money have different technical definitions. Typically a measure has a name consisting of the letter M followed by a number. The higher the number, the broader the measure. For example, in the United States a measure of paper cash, the amount in checking or demand deposit accounts in circulation is called M1. A broader measure including M1 plus savings accounts, money market acounts and CDs under 100,000, is called M2. The broadest measure in use in the U.S. is M3, which includes M2 plus all other CD's and eurodollars held by the US.

Money supply is important because it is directly linked to inflation by the simple equation:

  velocity[?] * money supply = real GDP[?] * GDP deflator
where velocity is the number of times per year that money changes hands. The GDP (Gross Domestic Product) deflator is a measure of inflation. In other words, if the money supply grows faster than real GDP, inflation must follow as velocity has been shown to be relatively stable.

As of about the year 2000, the M1 money supply was about 1.3 trillion dollars, the M2 was 5.4 trillion, and the M3 was 7.8. If you split all of the money equally per person in the United States, each person would end up with about 26,000.

The amount of actual physical cash was about half a trillion as of the year 2000. To put this in perspective, if everyone who was part of the largest US bank Citigroup tried to liquidate all of their assests from there, there would not be enough cash.

One of the principal jobs of central banks (such as the US Federal Reserve Bank, the Bank of England and the European Central Bank) is to keep money supply growth in line with real GDP growth. Central banks do this primarily by applying pressure to interest rates. The extent to which central banks can influence interest rates is limited because interest rates are determined by the free market actions of the bond markets[?].

A very common criticism of this policy, originating with the creators of GDP as a measure, is that "real GDP growth" is in fact meaningless, and since GDP can grow for many reasons including manmade disasters and crises, is not correlated with any known means of measuring well-being. This use of the GDP figures is considered by its own creators to be an abuse, and dangerous. The most common solution proposed by such critics is that money supply (which determines the value of all financial capital, ultimately, by diluting it) should be kept in line with some more ecological and social and human means of measuring well-being. In theory, money supply would expand when well-being is improving, and contract when well-being is decreasing, giving all parties in the economy a direct interest in improving well-being.

This argument must be balanced against the near-dogma among economists, that the control of inflation is the main (or only) job of a central bank, and that any introduction of non-financial means of measuring well-being has an inevitable domino effect of increasing government spending[?] and diluting capital and the rewards of gainfully employing capital.

Currency integration is thought by some economists -- Robert Mundell, for example -- to alleviate this problem by ensuring that currencies become less competitive in the commodity markets, and that a wider political base be employed in the setting of currency and inflation and well-being policy. This thinking is in part the basis of the Euro currency integration in the European Union.

Money supply remains one of the most controversial aspects of economics itself.

See also: inflation, central bank, financial capital, economics



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