Monetary Aggregates - Money Supply In The Economy

The central bank is responsible for issuing money, and also conducts the monetary policy of a given country and ensures price stability and the value of money. The monetary policy pursued by the central bank depends primarily on the money supply.

Definition

Monetary aggregates are a measure of the money supply in domestic currency. Depending on what assets we consider as money, we talk about different monetary aggregates. There are several commonly accepted categories of money, we denote them with the letter M from the English word money.

The aggregates are ranked from the most liquid assets to the least liquid. Subsequent aggregates include an ever-wider range of financial assets classified as money.

We distinguish several monetary aggregates. They depend on what assets we consider to be money. It is worth noting that the detailed range of assets included in the given monetary aggregates may differ slightly in individual countries.

M0

The monetary base (or M0) is the total amount of a currency that is either in general circulation in the hands of the public or in the form of commercial bank deposits held in the central bank's reserves.

In simpler terms, it is the total amount of money directly issued by the central bank - the value of notes and coins that are in non-bank circulation, as well as that held by the banking system. The monetary base consists mainly of cash money, which is held by various enterprises, households or institutions. In addition, it is also made up of the required reserve of commercial banks held on accounts with the central bank, as well as the excess reserve, which consists of voluntary contributions of commercial banks with the central bank.

The monetary base is the basis for shaping the money supply. This is because it makes it possible to increase the circulation of money.

M1

Another type of aggregate is M1, otherwise known as M1 money or transaction money. As you can guess, this aggregate has a broader measure than the monetary base, because in addition to the position of the M0 aggregate, it also includes slightly less liquid assets. It is, for example, the entire value of current deposits, i.e. demand deposits held in commercial banks by private individuals, business entities and financial institutions that are not banks. These contributions can be in n gold and in currencies.

The M1 aggregate includes: the above-mentioned cash outside banks' vaults, as well as the value of current accounts of commercial banks with the central bank, the value of the required reserve on central bank accounts, and current deposits in gold and in currencies.

M2

The next in line is the M2 aggregate. Its other name is M2 money. And here, as in the case of aggregate M1, it includes assets with even less liquidity than aggregate M1. Therefore, in addition to the M1 aggregate, it also includes all term deposits in commercial banks with an original maturity of up to 2 years, as well as deposits with a notice period of no more than 3 months.

M3

The last monetary aggregate is the M3 aggregate, otherwise known as broad money or M3 money. It is the widest unit. Here, as in the previous cases, it includes all components of the M2 aggregate, and additionally also debt securities with an original maturity of up to 2 years, as well as liabilities of banks arising from repurchase agreements. The M3 aggregate contains the most assets, including those characterized by much lower liquidity. Thanks to the fact that it has the largest range of assets, it gives the best picture of how the money supply is shaped.

Impact of monetary aggregates

The study of monetary aggregates can generate important information on the financial stability and overall health of a country. For example, monetary aggregates that grow too fast can cause fear of high inflation rates.

If there is more money in circulation than is needed to pay for the same amount of goods and services, prices are likely to rise. In the event of a high rate of inflation, groups of central banks may be forced to raise interest rates or stop the growth of the money supply.

Source: investopedia.com, Begg D., Macroeconomy