You will learn about the following concepts
- Aggregates – what are they?
- Measures in the US
- Aggregates in the Euro zone
- and more…
In the previous articles we described what power a central bank has on affecting economic activity and what tools it uses to control money supply. In this chapter we will turn our attention to how money supply is measured and make you familiar with the term “monetary aggregates”.
Money supply is the total amount of monetary assets within an economy at any given time. Its important for central banks to measure and keep control over the amount of money flowing in the economy as sudden imbalances could have harmful effects. Too much money supply will spur inflation, while too little might impair economic growth. Policy makers need to reach a balance between growth and inflation by controlling money supply using the three types of tools, previously described in the chapter – changing interest rates, changing banks reserve requirements and conducting open market operations.
Best Forex Brokers for Sweden
In order to measure the amount of money available in the economy, central banks use the so-called monetary aggregates – broad categories gauging the total value of money supply. The different types of money aggregates are typically classified as “M”s and range between M0, the narrowest, and M3, the broadest, but central banks formulate their policy on different aggregates.
In our article we will provide examples of what monetary aggregates the Federal Reserve and the European Central Bank use.
Measures in the US
In the United States, the Federal Reserve tracks the M1 and M2 monetary aggregates and releases reports on their values each Thursday at 4:30 PM EST. The central bank uses them to measure the effects of its open-market operations.
There are also the M0 and the MB. The M0 reflects the dollar value of physical cash and coins, while the MB (Monetary Base) includes the M0 plus Federal Reserve Deposits, which only banks can have with the Fed.
According to the Federal Reserve, the M1 consists of:
– currency outside the US Treasury, Federal Reserve and the vaults of depository institutions
– travelers checks of nonbank issuers
– demand deposits at commercial banks less cash items in the process of collection and Federal Reserve float
– other checkable deposits.
The M2 money aggregate consists of:
– the M1 aggregate
– savings deposits (including money market deposit accounts)
– time deposits less than $100 000
– balances in retail money market mutual funds.
There is also the M3, which the Federal Reserve however discontinued to track as of March 2006. It consisted of M2 + all other certificates of deposits (such as large time deposits), deposits of eurodollars and repurchase agreements.
Not so popular, but still reliable
Since the 90s, the money supply indicators have become less popular due to a variety of changes in the US financial system and the way the Fed conducts monetary policy. There has been seen a lower correlation between changes in the money supply and key economic gauges like GDP, unemployment and inflation.
Currently, the central banks monetary policy is more clearly understood by observing the level of funds the Federal Reserve is injecting into the economy. This is why monetary aggregates are rarely a market mover in the short term.
However, the more widely tracked M2 is deemed useful as it indicates that inflation could be around the corner, despite the fact it does not directly indicate future spending growth as it once did. It can provide preliminary information about a possible rise in inflation when compared to GDP growth. If the rise in money supply swiftly outpaces economic expansion, there will soon be a pick up in prices.
Aggregates in the Euro zone
Meanwhile, the European Central Bank has defined three aggregates used in the Euro zone – a narrow aggregate M1, an intermediate M2 and a broad M3. They are comprised of the following components:
– M1 = currency in circulation + overnight deposits (which can be immediately converted into currency or used for cashless payments)
– M2 = M1 + deposits with an agreed maturity of up to 2 years + deposits redeemable at a period of notice up to 3 months. The definition of M2 reflects the interest in monitoring a monetary aggregate that, in addition to currency, consists of deposits which are liquid.
– M3 = M2 + repurchase agreements + money market fund shares/units + debt securities up to 2 years. These instruments are characterized by a high degree of liquidity and price certainty, which makes them close substitutes for deposits. Their inclusion leaves the M3 less affected by substitution between various liquid asset categories than narrower definitions of money, making it more stable.