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3.5 Measuring Money

Learning Objective

  1. What is the money supply and how is it measured?

Due in part to the profusion of different types of credit money, measuring the money supply today is no easy task. The Fed, or Federal Reserve System, America’s monetary authority and central bank, has therefore developed a number of monetary aggregates, or different measures of the money supply. The monetary base (MB or M0, the narrowest aggregate) is the unweighted total of Federal Reserve notes and Treasury coins in circulation, plus bank reserves (deposits with the Federal Reserve). M1 adds to M0 travelers’ checks and demand deposits. (Banks other than the Fed no longer issue notes. If they did, they would be considered components of M1.) A broader aggregate, M2, includes M1 as well as time/savings deposits and retail money market mutual fund shares. A yet broader aggregate, M3, includes M2 as well as institutional time deposits, money market mutual fund shares, repurchase agreements, and Eurodollars, but its publication was discontinued by the Fed in 2006.

The Fed continues to estimate the other three measures because their movements are not highly correlated and the appropriate monetary aggregate varies over time and question. As we will see, the money supply helps to determine important macroeconomic variables like inflation, unemployment, and interest rates. Accurately measuring the money supply is so important that monetary economists still search for better ways of doing it. One approach, called divisia after its French inventor, François Divisia (1925), weighs credit instruments by their liquidity, or in other words, their degree of money-ness, or ease of use as a medium of exchange. The Federal Reserve Bank of Saint Louis tracks the U.S. money supply using various divisia formulas.research.stlouisfed.org/msi/

Each Friday, the Wall Street Journal publishes the M1 and M2 monetary aggregates in its “Federal Reserve Data” column. The data is also available on the Federal Reserve’s Web site: http://www.federalreserve.gov/releases/h6/. Students are cautioned, however, that the published data are mere estimates; the Fed often revises the figures by as much as 2 or 3 percent. Other countries’ central banks also report their monetary aggregates. Links to the Web sites of other central banks can be found here: http://www.bis.org/cbanks.htm.

Key Takeaways

  • The money supply is the stock of all money in an economy.
  • It is measured in a variety of ways to aid in the conduct of monetary policy and in macroeconomic forecasting.