Three Measures of Money Supply

Updated Oct 13, 2020

Money supply (i.e., money stock) is defined as the total quantity of money circulating in the economy at a particular time. Many countries commonly use it as an indicator of economic performance. However, in our financial system, money is not limited to cash anymore. There are several other physical and intangible assets that perform many or all of the functions of money. Thus, depending on the scope we chose, the money supply can be larger or smaller. Therefore, most countries distinguish between at least three measures of money supply, M1, M2, and M3. We will look at each of them in more detail in the video and the text below.

M1 – Narrow Measure

M1 includes all currency (i.e., cash) in circulation, traveler’s checks, demand deposits at commercial banks (or other depository institutions) held by the public, and other checkable deposits. It is often referred to as the narrowest measure of money supply or narrow money. However, for the sake of completeness and to avoid confusion, please note that some countries also measure a similar, but even narrower money supply M0 (e.g., UK).

In the United States, the Federal Reserve reports M1 on a weekly and monthly basis. The reports always include a seasonally adjusted and a not seasonally adjusted value. Seasonal adjustment is a statistical technique that is designed to even out periodically recurring patterns that are due to seasonal changes in supply and demand. The idea behind this is to reveal non-seasonal changes that would otherwise be overshadowed by seasonal changes.

In May 2017, the Federal Reserve reported the US money stock M1 at USD 3,462.4 billion (not seasonally adjusted) and USD 3,428.7 billion (seasonally adjusted). Over the last few years, M1 has consistently increased. In fact, it has grown by 7.1 percent in just one year from April 2016 to April 2017.

M2 – Intermediate Measure

M2 includes everything in M1 as well as savings deposits, time deposits below USD 100,000, and balances in retail money market funds. It is often referred to as an intermediate measure because it is broader than M1 but not quite as broad as M3.

It is also reported weekly and monthly by the Federal Reserve. M2 plays an essential role in any discussion about money supply because it often provides more comprehensive insights than M1 alone. Many economic activities include transactions between different types of accounts, which is only partially included in M1.

In May 2017, the US not seasonally adjusted money supply M2 was reported at USD 13,520.9 billion, and seasonally adjusted at USD 13,431.3 billion. M2 has also experienced steady growth over the last years. According to the latest report, it has increased by 6.0 percent from April 2016 to April 2017.

M3 – Broad Measure

M3 includes everything in M2 as well as time deposits larger than USD 100,000, balances in institutional money market funds, and term repurchase agreements. It is considered the broadest measure of the money supply. Again, for clarification, it should be noted that some countries (e.g., UK) report M4, a similar, but not quite identical measure to M3.

The Federal Reserve stopped reporting M3 back in 2006, because, according to the board, M3 does not include any relevant information on economic activity that is not already embodied in M2. Therefore the costs of collecting and publishing the data outweighed the benefits.

Summary

Money supply is defined as the total quantity of money circulating in the economy at a particular time. Many countries use it as an indicator of economic performance. There are three measures of money supply M1, M2, and M3. M1 includes all currency in circulation, traveler’s checks, demand deposits at commercial banks held by the public, and other checkable deposits. M2 includes everything in M1 as well as savings deposits, time deposits below USD 100,000, and balances in retail money market funds. And last but not least, M3 includes everything in M2 and time deposits larger than USD 100,000, balances in institutional money market funds, and term repurchase agreements.