Money supply

Cash in your pocket certainly serves as money; however, what about checks or credit
cards? Are they money, too? Rather than trying to state a single way of measuring
money, economists offer broader definitions of money based on
liquidity. Liquidity refers to how quickly you can use a financial asset to buy a good or
service. For example, cash is very liquid. You can use your $10 bill easily to buy a
hamburger at lunchtime. However, $10 that you have in your savings account is not so
easy to use. You must go to the bank or ATM machine and withdraw that cash to buy
your lunch. Thus, $10 in your savings account is less liquid.
Money supply in an economy is the total volume of currency in circulation at a particular point in
time. It can include cash and its equivalents like currency notes, coins, and bank deposits. It is a
critical concept that greatly impacts a country’s financial and economic situation. The supply of
money is closely related to inflation and consumption. Therefore, the government, especially a
country’s central bank, controls the circulation of money through its monetary policy. The supply
of money measurement include M1, M2, M3, types, based on its liquidity.
MB indicates the monetary base in the above formula, C is the currency in circulation, and R is
the reserve balances. Reserve balances are the total deposits of all kinds of depository
institutions in their accounts at the Federal Reserve or the nation’s central bank.
MB=C+R
A country has $300 million currency in circulation, and its central bank holds $70 million as deposits from
banks and other depository institutions. In total, the country’s MB is $370 million. The calculation is as follows:

MB = C + R

MB = $300 million + $70 million = $370 million.

The quantity of money available for the public is a key determinant in many economic variables because
changes in the money supply affect interest rates, inflation, consumption, and savings. Not all money is
considered a part of the money supply. To remedy this problem, economists have come up with several
definitions of the money supply:
M1 is known as narrow money as it includes only 100% liquid deposits which is a very narrow definition
of the money supply.
M1=cash+ checkable deposits+savings deposits+ traverls check

■ M1 (the most liquid form of the money supply)

■ All currency in the hands of the public (paper money and coins)
■ All checkable deposits in commercial banks
A checkable deposit means any deposit held at a bank or another financial institution that is highly liquid and thus
can be accessed at any point of time on the issuance of a cheque. Deposits in financial institutions against which
checks can be written (Checkable deposits are liabilities of the issuing banks.)
M1 now includes savings deposits in banks, which are bank accounts on which you cannot write a check directly,
but from which you can easily withdraw the money at an automatic teller machine or bank.
Currency sitting in bank vaults is not included as part of the money supply, because it is not being used as a
medium of exchange. Checkable deposits are money because their owners can write checks against them.
Travelers checks
 Traveler’s checks are a form of payment issued by financial institutions such as
American Express. These paper cheques are generally used by people when
traveling to foreign countries.
 They are purchased for set amounts and can be used to buy goods or services or be
exchanged for cash.
 If your traveler's check is lost or stolen it can readily be replaced.
 Once widely used, traveler’s checks have largely been supplanted today by prepaid
debit cards and credit cards.
 Savings deposits – Deposits that earn interest but have no specific maturity date

M2 encompasses M1 along with the following types of money:
M2 money supply is now measured as M1 plus time deposits, certificates of deposits, and money market
funds.
■ Time deposits
■ Certificates of deposit ($100,000 or less)
■ Money market mutual funds
A mutual fund is a company that pools money from many investors and invests the money in securities
such as stocks, bonds. The combined holdings of the mutual fund are known as its portfolio. Investors
buy shares in mutual funds. Each share represents an investor’s part ownership in the fund and the
income it generates.
While the components of M1 are the most liquid assets, M2 includes M1 and less liquid assets. In other words:
M2 = M1 + time deposits, CDs ($100,000 or less), and money market mutual funds
Time deposits – Deposits that earn a fixed rate of interest if held for the specified period,
which can range anywhere from several months to several years. his is the time deposit,
commonly known as a (CD).

A time deposit is a bank account that takes in an amount of cash that will bear interest with a
pre-set Maturity date. It pays a higher interest rate compared to a regular savings account. At
the same time, there is no limitation as to when one can withdraw money from a regular
savings account, the time deposit locks in the money within a certain time. The longer the bank
keeps the money, the higher the interest payment it offers to the depositor. The interest
payment is an amount earned by having the money in the bank for the term or period. Time
deposits are also called term deposits.
M1 is the most common form of the money supply. Consumers can use M1 for direct
transactions and instant exchange for goods and services.
Finally, M3 consists of M1, M2, and large-time deposits (certificates of deposits) of over
$100,000:
M3 = M2 + large-time deposits
Businesses usually own large-time deposits, which are used for future investments.
M3
M3 is called Broad money as along with liquid deposits it also includes time deposits thus
making it a broad classification of Money.