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What is 'Money Supply'

Money supply is the entire stock of currency and other liquid instruments circulating in a country's economy as of a particular time. Also referred to as money stock, money supply includes safe assets, such as cash, coins, and balances held in checking and savings accounts that businesses and individuals can use to make payments or hold as short-term investments.

BREAKING DOWN 'Money Supply'

Economists analyze the money supply and develop policies revolving around it through controlling interest rates and increasing or decreasing the amount of money flowing in the economy. Money supply data is collected, recorded and published periodically, typically by the country's government or central bank. Public and private sector analysis is performed because of the money supply's possible impacts on price level, inflation and the business cycle. In the United States, the Federal Reserve policy is the most important deciding factor in the money supply.

How Money Supply is Measured

The various types of money in the money supply are generally classified as Ms, such as M0, M1, M2 and M3, according to the type and size of the account in which the instrument is kept. Not all of the classifications are widely used, and each country may use different classifications. M0 and M1, for example, are also called narrow money and include coins and notes that are in circulation and other money equivalents that can be converted easily to cash. M2 includes M1 and, in addition, short-term time deposits in banks and certain money market funds. M3 includes M2 in addition to long-term deposits. However, it is no longer included in the reporting by the Federal Reserve. MZM, or money zero maturity, is a measure that includes financial assets with zero maturity and that are immediately redeemable at par. The Federal Reserve relies heavily on MZM data because its velocity is a proven indicator of inflation.

The Effect of Money Supply on the Economy

An increase in the supply of money typically lowers interest rates, which in turns generates more investment and puts more money in the hands of consumers, thereby stimulating spending. Businesses respond by ordering more raw materials and increasing production. The increased business activity raises the demand for labor. The opposite can occur if the money supply falls or when its growth rate decline.

Historically, the measure of money supply has shown that relationships exist between certain economic factors and inflation, which was used as a determinant of the future direction of price levels and inflation. However, since 2000, these relationships have become unstable, reducing their reliability as a guide for monetary policy. Although money supply measures are still widely used, they are no more important than the wide array of economic data that economists and the Federal Reserve collects and reviews.

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