Money and Banking 3

Prof Dr Gaber Mohamed Abdel Gawad

2023-2024

Prof Dr Gaber M Abdel Gawad 10/22/2023 1

Money Supply

 Introduction
Money supply in any economy is not limited to cash only but includes all means of
payment, and the economy in the modern era is no longer satisfied with cash
transactions after the spread of modern payment methods such as debit and
credit cards or smart cards and bank facilities. These means are subject to
regulation by central banks as part of the money supply in the economy
The money supply is the main tool used by the monetary authority represented
by the Central Bank in directing its monetary policy towards achieving internal
and external stability of the economy, through its impact on economic variables.
The effects of the money supply on these variables are of great importance in
directing monetary policies

Prof Dr Gaber M Abdel Gawad 10/22/2023 2

Money supply

 An increase in the money supply in the economy may lead

to stimulating purchasing power and increasing investment
rates, but a large increase in the money supply without
prior planning and study of its results can lead to opposite
results, and that increase in the money supply may end in a
significant increase in prices only. Reducing the money
supply in the wrong way also leads to negative results in the
emergence of a recession, which can turn into a general
depression in the economy. This clarifies the importance of
studying these different measures of the money supply.
Prof Dr Gaber M Abdel Gawad 10/22/2023 3
Measures of money supply

 Measures of money supply differ according to what each of these

measures contains - along with cash in circulation - of the types of
financial assets that enjoy some degree of liquidity. There is no
universally applicable empirical definition of money supply, and the
choice may vary dependent on liquidity assets included in the money
supply. There are varying degrees of liquidity depending on how easily
an asset can be converted into other assets. The most liquid assets
are banknotes and coins established as a medium of exchange, other
assets depend on how easily they may be converted to banknotes and
coins.

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Measures of money supply

 According to that, there are three official

measures of the money supply ranging from M1,
the narrowest measure, to M3, the broadest
measure. The formula for calculating money
supply varies from country to country. For
example, the Federal Reserve in the United States
provides only two main measures of money – M1
and M2, where M1 is the narrowest and M2 the
broadest. The European Central Bank provides
three measures of money – M1, M2, and M3,
Prof Dr Gaber M Abdel Gawad 10/22/2023 5
Measures of money supply

 1) The Narrowest Money Supply (M1)

 This measure is based on the fact that money is a medium of exchange for
goods and services in society, and therefore it is distinguished from other
assets in carrying out this function. Accordingly, that measure of money
includes only assets that are used as a medium of exchange, and these assets
are paper money in circulation with individuals (banknotes), auxiliary money,
and deposit money (current deposits), in addition to traveler’s checks. This is
the most liquid measure of money. Therefore, the money supply, according to
this measure (M1) is calculated by this equation:
 M1 = banknotes and coins in circulation outside the Bank + Demand deposit
money + traveler’s cheques.

Prof Dr Gaber M Abdel Gawad 10/22/2023 6

Measures of money supply

 2) The Broad Money Supply (M2):

 This measure of the money supply is based on the function of money as a
store of value. According to this measure, the money supply includes, in
addition to the components of M1, other less liquid components such as
savings deposits, and small time deposits in commercial banks (in the USA,
those issued in amounts of less than $100,000), and money market mutual
fund. It is often referred to as a broad money supply because it is broader
than M1 but not quite the broadest M3.

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Measures of money supply

 Although some of these assets are not readily accepted as payment for goods
and services, the transaction cost associated with their conversion is
relatively small. For example, with the introduction of automated banking
machines, holders of savings account no longer have to go directly to the bank
to make withdrawals thus the burden of converting savings balances to cash is
minimized. As such, savings accounts are now used similarly to current
accounts in many societies. On the other hand, time deposits (such as
certificates of deposit) are accounts that the depositor has committed to
leaving in the bank for a certain period, ranging from a few months to a few
years, in exchange for a higher interest rate. Since these deposits can be
withdrawn on short notice, they also provide some degree of liquidity to
depositors. It should also be noted that there is an interest penalty associated
with the premature closure of these accounts.

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Measures of money supply

 A money market fund (also called a money market mutual

fund) is a mutual fund that invests in short-term debt
securities with minimal credit risks such as US Treasury
bills and commercial paper. Money market funds offer
investors high liquidity with a very low level of risk.
 M2 = M1 + savings deposits + time deposits + money
market funds

Prof Dr Gaber M Abdel Gawad 10/22/2023 9

Money supply

 3) The Broadest Money Supply (M3):

 The M3 classification is the broadest measure of an economy's money supply.
In addition to the components of the M2 money supply, M3 includes other less
liquid assets (not easily convertible to cash and therefore not ready to use if
needed right away). These assets include large time deposits, savings, and
time deposits in non- bank financial institutions (institutional money market
funds such as insurance institutions and post offices), government deposits
with commercial banks, and deposits in foreign currencies.

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Money supply

 In Egypt, there are two measures of Money Supply:

 M1 includes currency in circulation outside the banking system + demand
deposits in local currency.
 M2 (which is called domestic liquidity) includes M1 + Quasi Money.
 Quasi money includes local currency time & saving deposits + foreign currency
demand deposits + foreign currency time & saving deposits. The following
table shows measures of money supply in Egypt during 2018-2020.

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Table (1) Egypt s M1&M2 money supply

Banking Survey: Domestic Liquidity 2018 2019 2020

(LE mn) Jun Jun Jun
Domestic Liquidity (1+2) (M2) 3454321 3863642 4538808
Money Supply (1) (M1) 820574 923562 1084742
Currency in circulation 438857 487233 602732
Demand deposits in local currency 381717 436329 42010
Quasi Money (2) 2633747 2940080 3454066
Local currency time & saving deposits 1916789 2225449 2787423
Foreign currency demand deposits 149769 143284 142022
Foreign currency time & saving deposits 567189 571347 524621

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Money supply

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