Broad Money

Updated Aug 6, 2023

Definition of Broad Money

Broad money, often referred to as M3 (see also measures of money supply), is a comprehensive measure used to gauge the total amount of money circulating within an economy. It encompasses all forms of money, including physical currency (cash and coins) as well as various types of deposits held by individuals, businesses, and financial institutions. These deposits include demand deposits, savings deposits, time deposits, and other liquid assets.

Example

Let’s consider a hypothetical scenario in a small country to illustrate the concept of broad money. The total money supply in this country amounts to $100 billion. Out of this total:

• $20 billion exists in the form of physical cash and coins circulating in the economy.
• $30 billion is held as demand deposits, which are funds deposited in banks that account holders can access on demand through checks or electronic transfers.
• $50 billion is in the form of savings deposits, which represent funds placed in savings accounts, often accruing interest.

By summing up the currency, demand deposits, and savings deposits, we find that the total amount of broad money in the country is $100 billion.

Why Broad Money Matters

Broad money is a crucial economic indicator monitored by central banks and governments to assess the overall health and activity of an economy. As the most comprehensive measure of money supply, it provides valuable insights into the liquidity and financial conditions of a nation.

• Economic Activity: An increase in M3 is often associated with economic growth and expansion. When more money is in circulation, it can spur consumption, investment, and lending activities, driving economic activity.
• Inflationary Pressures: A significant surge in broad money may indicate potential inflationary pressures. If the increase in money supply outpaces the growth of goods and services in the economy, it can lead to rising prices and reduced purchasing power.
• Monetary Policy: Central banks use data on M3 to formulate and implement monetary policies. By managing the money supply, they can influence interest rates, credit availability, and overall economic stability.
• Financial Stability: Monitoring M3 helps assess the stability of the financial system. A sudden decrease in money supply could be indicative of a financial crisis or a credit crunch.
• Currency Stability: In the context of exchange rates, the amount of broad money can influence the value of a country’s currency in international markets. A significant change in the money supply may impact the exchange rate’s stability.

By closely analyzing changes in broad money, policymakers can make informed decisions to promote economic growth, control inflation, and ensure financial stability within the economy. Understanding and managing the money supply is an essential tool for central banks and governments to steer their economies in the desired direction.