What Is Broad Money?
Broad money is a category for measuring the amount of money circulating in an economy. It is defined as the most inclusive method of calculating a given country's money supply, 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.
- Broad money is the most flexible method for measuring an economy's money supply, accounting for cash and other assets easily converted into currency.
- The formula for calculating money supply varies from country to country, so the term broad money is always defined to avoid misinterpretation.
- Central banks tend to keep tabs on broad money growth to help forecast inflation.
Understanding Broad Money
Since cash can be exchanged for many different financial instruments, and be placed in various restricted accounts, it is not a simple task for economists to define how much money is currently circulating in any one economy. Therefore, the money supply is measured in 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.
The formula for calculating money supply varies from country to country, but broad money is always the farthest-reaching, encompassing both highly liquid assets, cash, and checkable deposits, known as "narrow money," together with slightly more illiquid forms of capital. Broad money usually accounts for "near money" as well, such as certificates of deposit (CDs), foreign currencies, money market accounts, marketable securities, Treasury bills (T-Bills) and anything else that can be easily converted into cash—excluding shares in a company.
Example of Broad Money
In the United States, the most common measures of 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 coins and notes in circulation. At the other end of the scale is M3, which is categorized as the broadest measurement of money.
Different countries often define their measurements of money slightly differently. In academic settings, the term broad money is used to avoid misinterpretation. In most cases, broad money means the same as M3, while M0 and M1 usually refer to narrow money.
The Organisation for Economic Co-operation and Development (OECD) characterizes broad money as any currency or deposits with an agreed maturity of up to two years, deposits redeemable with up to three months' notice, and repurchase agreements (Repo), money market fund shares/units, and debt securities up to two years.
Benefits of Broad Money
Widening the scope of the total money in circulation comes with several advantages. Above all, it helps policymakers to get a greater grasp of potential inflationary trends—how much the prices of goods and services are likely to rise. Central banks often look at broad money, alongside narrow money, to determine which monetary policies are required in any given moment to keep the economy in check.
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 the goal is 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 available, the economy tends to accelerate because businesses have easy access to financing. If there is less money in the system, the economy slows and prices may drop or stall. In this context, broad money is one of the measures that central bankers use to determine what interventions, if any, they could introduce to influence the economy.