| The dismal science|
Why it matters
“”Inflation is everywhere and always a monetary phenomenon.
Aggregating money is important for conducting monetary policy, especially given that central banks are now recognized as the agent in an economy most capable of determining the money supply, and thus inflation.[note 2] Since the 1980s more and more central banks have begun to focus on the growth rate of the money supply in an economy and the subsequent impact it has on inflation, inflationary expectations, and interest rates. Prior to this, the predominant view held by economists was that interest rates were the best way to judge the stance of monetary policy. Money supply growth and inflation are now seen as much more significant. While this would suggest that central bankers should focus on targeting the growth rate in the money supply, interest rate targeting has remained the primary tool for controlling inflation.[note 3] Attempts at targeting the growth of the money supply were generally considered unsuccessful, as the Federal Reserve adopted a quasi-monetarist approach in the 1980s to limited success.[note 4] Still, it's critical to know the rate at which the money supply is growing to gauge the relative stance of monetary policy. Complicating factors include determining which measure of the money supply to prioritize. In the United States each of the main measures grow at different rates and respond to changes in short-term interest rates differently. Currently, M2 is the main focus of The Fed.
Measuring money is not necessarily a straightforward task. While physical currency, like Federal Reserve and Treasury notes,[note 5] are obviously part of the money supply, many interest-bearing financial assets are more ambiguous. Broader measures seek to include certain types of financial assets that could be substituted for money. From an accounting point of view, assets that yield interest aren't that different from interest-bearing currency held in a savings or checking account.[note 6] Some less-liquid financial assets (mutual funds, time deposits, certificates of deposit) are less liquid than money, so different methods of aggregation are used to include them. Unlike more-conventional forms of money which can be immediately withdrawn from some types of bank accounts, these other less-liquid types cannot be immediately withdrawn, absent some type of financial penalty.
Some basic measures of the money supply in the United States of America include the following.
- M0: The most basic measure of money. This only includes physical currency in circulation and some depository institutions.
- MB: The monetary base (sometimes called high powered money) includes M0 as well as all physical currency in vaults (vault cash) and that any reserves banks hold with the Federal Reserve System, be they excessive or required.
- M1: M1 disregards the aforementioned vault cash and bank reserves. However, it also includes demand deposits, negotiable order of withdrawal (NOW) accounts, traveler's checks and some other checkable accounts.
- M2: This measure aggregates savings deposits, time deposits, and certain money-market funds in addition to anything included in M1.
- M3: Discontinued by the Federal Reserve since 2006, M3 included M2 measures and some large time-deposits and other types of money-market funds.
- Monetarism A macroeconomic body of thought and research prioritizing money.
- Federal Reserve The central banking system in charge of America's money supply.
- Milton Friedman Some guy who couldn't take his mind off of the money supply.
- More expansive definitions of money often include less liquid assets like money market funds.
- While a central bank may only be able to indirectly influence broader measures, they can induce as much growth in the monetary base as they want. Regarding Japan's slump, Milton Friedman stated quite bluntly, "There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so."
- Milton Friedman, an advocate of money supply targeting, was of the opinion that interest rate targeting was just a roundabout way of managing the growth of the money supply.
- Inflation was brought under control by Paul Volker's Fed, but the Fed consistently failed to hit it's money supply growth targets and directly targeting growth in the money supply was ultimately abandoned.
- Treasury notes are still legal tender in the United States, but are no longer printed.
- Both the money in a savings account and a Treasury Bond pay interest. However, one normally can't use a Treasury Bond to pay for one's meal at a restaurant. This raises legitimate questions about what constitutes money.
- Chappelow, Jim. "Money Supply". Investopedia. Retrieved February 12, 2020.
- Reviving Japan by Milton Friedman (April 30, 1998) Hoover Digest No. 2 (archived from November 2, 2019).
- Schwartz, Anna J. "Money Supply". Econlib. Retrieved February 12, 2020.
- The U.S. Monetary Experience of 1979-1982 by Mark Thoma (July 06, 2008) Economist's View.
- Ruby, Douglas A. "The Money Supply Process and Interest Rate Determination". Retrieved Feb 17, 2020.
- Chappelow, Jim. "M1". Investopedia. Retrieved February 12, 2020.
- Chappelow, Jim. "M2". Investopedia. Retrieved February 12, 2020.
- "Discontinuance of M3". Federal Reserve, March 9, 2006.