What is 'Broad Money'
Broad money is the most inclusive method of calculating a given country's money supply. The money supply is the totality of assets that households and businesses can use to make payments or to hold as short-term investments, such as currency, funds in bank accounts and anything of value resembling money. The formula for calculating money supply varies from country to country, but broad money is always the farthest-reaching; narrow money includes fewer elements in the calculation.
BREAKING DOWN 'Broad Money'Since cash can be exchanged for many different financial instruments, and it can be placed in various restricted accounts, it is not a simple task for economists to define how much money is currently in a given economy. Therefore, the money supply is measured in many different ways. Economists use a capital letter "M" followed by a number to refer to the calculation that they are using in a given context.
Money Supply in the United States
In the United States, the most common measures of the money supply are termed M0, M1, M2 and M3. These measurements vary according to the liquidity of the accounts included. M0 includes only the most liquid instruments, such as cash or assets that could quickly be converted into currency, so it is the narrowest definition of money. M3 includes liquid instruments as well as some less liquid instruments and is therefore considered the broadest measurement of money. In the United States, M3 is what is colloquially referred to as broad money.
Different countries often define their measurements of money slightly differently. In academic settings, the term "broad money" is always defined in context to prevent potential misunderstandings.
Practical Use of Broad Money and Money Supply
Economists have found close links between money supply, inflation and interest rates. Central banks, such as the U.S. Federal Reserve, use lower interest rates to increase the money supply when they want to stimulate the economy. Conversely, in an inflationary setting, interest rates are raised and the money supply diminishes, leading to lower prices.
In simple terms, if there is more money to go around, the economy tends to accelerate, with businesses having easy access to financing. If there is less money in the system, the economy cools off and prices may drop or stop rising. In this context, broad money is one of the measures that central bankers use to determine what interventions, if any, they choose to make in the economy.