What is money supply?

The money supply is the entire money supply of an economy. The money stock means the cash and book money that is in the possession of non-banks. All public administrations, companies and private citizens are considered non-banks. The money that is managed by the banks does not play a role in determining the amount of money.

This lesson is about the amount of money. You will get to know the different types of money supply and learn how the different amounts of money are made up. Finally, you will be informed about how the money supply can be regulated and who is responsible for it. To deepen your knowledge, you can answer four exercise questions after the text.

  • English: money supply
  • Synonym: volume of money

Why is the money supply important to the economy?

According to gradphysics, the money supply is closely related economically to the goods and services in demand. The money supply provides information on the development of market prices. That is why both producers and consumers are interested in this economic size.

In the economy, money is not only used as a means of payment. If the money z. B. invested in a savings account, it is a means of storing value. For this reason, it is necessary to divide the money supply into four types. The four types show the availability of money.

The four types of money

There are different types of money in an economy. Therefore the following distinction is made:

  • Money supply M0
  • Money supply M1
  • Money supply M2
  • M3 money supply

The 4 amounts of money: M0, M1, M2, M3

The money supply M0

All cash holdings that are outside of a banking system are included in the money supply M0.

The M1 money supply

The money supply M1 comprises all cash stocks that circulate daily within a banking system. About this money can be withdrawn immediately. Therefore, the money stock M1 is ascribed a high level of liquidity.

The money supply M2

If savings and time deposits are added to the cash holdings, the result is the amount of money M2. However, only savings deposits that have a notice period of up to three months are relevant.

Time deposits are financial resources that an investor puts in a bank and receives a fixed rate of interest in return. Time deposits are set for a term that is no less than two years. Nevertheless, the liquidity of the M2 money supply is still very high.

money supply

The M3 money supply

The money stock M3 includes all funds that are included in the money stock M2. The shares in money market funds and other money market paper are added to this total. Another component of the M3 money supply are bonds with a term of two years.

How is the money supply regulated?

The money supply is controlled by the central banks of an economy. The central bank is a central bank whose main task is to regulate monetary policy for a country or currency area. The European Central Bank (ECB) does this by influencing the key interest rate. If the ECB raises or lowers the key interest rate, the conditions under which it passes money on to the commercial banks change.

An increase in the key interest rate reduces the amount of money. A cut in interest rates means that more money comes into circulation. This is due to the favorable terms on which a commercial bank borrows money from the central bank.

If the creation of money is also operated by a commercial bank, an undesirable effect can occur: The money supply increases to an extent that is not wanted by the central bank.

Example

The customer of a bank pays € 1,600 into his current account. 50% of the money stays with the bank. € 800 will be passed on to a borrower. This borrower uses the money to buy a laptop. The seller puts the collected € 800 with another bank. The second bank also keeps half of the deposited money. The bank makes the remaining amount available to other borrowers.

If this cycle is continued, the money supply increases continuously. To counteract this, the central bank introduced the minimum reserve policy. According to this, a commercial bank is obliged to deposit 10% of its deposits with the central bank.

 

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