Series 7

Securities Markets - Monetarist Theory



  • Monetarist theory, developed in the 1950s by Milton Friedman, was the driving force of Ronald Reagan's "supply-side" economics of the 1980s. It places less emphasis on expenditure and more on money supply.
We all know what "supply" is, but "money" is harder to define. First and foremost, money is a medium of exchange - an asset used to buy and sell goods and services. Currency in circulation is money by anyone's definition, but what about funds invested in CDs? Are they money or are they long-term assets? What about the trillion dollars or so that flows through banks every night on its way to making substantive purchases? Is it part of the nation's cash on hand, or does it represent investment? The further the dollar-denominated asset veers from being a simple medium of exchange, the harder it is to categorize. That is why economists identify three separate money supplies:
  • M1: Notes and coins in circulation, money in checking accounts, and travelers' checks.

  • M2: M1 plus savings accounts, small- and medium-sized CDs and small- and medium-sized money market mutual fund shares.

  • M3: M2 plus CDs over $100,000, money market mutual fund shares over $100,000, overnight loans from customers and U.S. residents' dollar-denominated deposits at financial institutions outside the U.S.



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