Money supply is the total amount of money available in an economy at any particular point in time.
Money is required for both consumers and businesses to make purchases.
Money is defined as currency in circulation and demand deposits (funds held in bank accounts.)
Different types of money in supply
Money is classified (as “M”) into different categories ranging from M0 to M3 and with few exceptions these categories are similar worldwide.
- M0 money supply refers to: physical currency, that is actual dollar bills and coins that individuals keep in their wallets (or hidden under the mattress!)
- M1 money supply refers to: M0 + funds in deposit at banking institutions.
- M2 money supply refers to: M0 + M1 + small time deposits (deposits of less than $100,000 that can not be redeemed before a certain date.)
- M3 money supply refers to: M0+ M1 +M2 + large time deposits (deposits exceeding $100,000 that can not be redeemed before a certain date) + large liquid assets (example, stocks) + short term repurchase agreements (a form of short term investment) + institutional money-market funds (mutual fund that invests in short term debt)
Importance of Money Supply relating to Inflation
Money supply is important because it is directly linked to inflation. A country whose money supply increases rapidly will experience inflation.
A prime example of this is Zimbabwe, which has seen inflation increase in the tens of thousands percent because the government continuously printed large amounts of money.
In fact, a one hundred trillion dollar Zimbabwe bank note can be purchased on EBay for less than US$1, because even that has lost all value as the government continued to print new money.
The money supply data is not exactly a short term “market mover” because it is reported very frequently. In the United States money supply data is published weekly and often the change from one week to the next is minimal.
The data is used by economists and investors as there are complex relationships between money supply and GDP growth as well as inflation.
Historically the money supply tends to rise faster during periods of economic expansion.
Investors who closely monitor the money supply data can take this opportunity to buy stocks.
Perhaps the most important of the “M” figures is M2, which represents cash and cash equivalents. These funds are considered to be liquid in the sense that all holdings can easily be converted to cash if need be.
While growth in the M2 money supply does not directly indicate future spending, it can be an indication that inflation is a possibility.
A good comprehension of economics and money supply is beneficial should the M2 supply outpace economic growth, resulting in the fact that more money is now “chasing” after the same amount of goods.