How is money supply measured? (Measures of money supply)

Money supply is pretty self-explanatory. Money supply is the amount of a certain currency that is in circulation in an economy.

The money supply is made out of:

  • Physical bills in circulation
  • Physical bills held by banks in their reserves
  • Money in checking accounts
  • Money in saving accounts (under $100K) and CDs
  • Long-term savings accounts (over $100K), Institutional money market funds and other larger liquid assets

Measures of money supply

Money Supply MeasureFormulaNotes
M0Physical Bills In CirculationThis refers to physical dollar bills.
MBM0 + Physical Bills Held In Bank ReservesThe physical bills are not technically in circulation but can be put into circulation very easily.
M1M0 + Checking AccountChecking accounts are technically not in circulation but account holders (e.g. you and I) can withdraw them at any time.
M2M1 + Savings Account + CDsSavings accounts under $100K.
M3M2 + Long-Term Savings Account + Institutional Money Market Funds + Other Larger Liquid AssetsLong-term savings account means accounts with over $100K. M3 still doesn’t include stocks or gold.

Notes from the “Measures of money supply” table

  • A checking account is a bank account that does not pay interest. Supposedly, its easier to withdraw cash from a checking account. (e.g. UOB Current account)
  • In Singapore, checking account is often called a checking account.
  • A savings account is a deposit account that provides interest for money held in a bank. (e.g. POSB eSavings account)
  • A savings account is less liquid that a checking account but can still be converted to cash quickly.

Applying measures of money supply to an individual

To help you better understanding how M0, M1, M2 and M3 are used, let’s take an example.

John is a university graduate with the following net worth:

  • $50 cash in his pocket
  • $5,000 in a regular POSB eSavings account
  • $150,000 in a special savings account with a very high interest rate (he’s saving up to buy a property)
  • $2,000 in stocks

Using the measures of money supply and treating John as an economy:

  • M0 = $50
  • M1 = $50
  • M2 = $550
  • M3 = $150,550

Which money supply measure should I look at?

Obviously, you should focus on M3. While M3 does not include assets such as stock, M3 does include Treasury bonds which is how the central bank injects money into the economy. (The central bank buys Treasury bonds with “made up” money.)

How does the central bank control the money supply?

Monetary policy. This is the increase or decrease of interest rates. If the central bank lowers interest rates, more people will borrow money. If more people borrow money, there will be more cash in circulation due to the multiplier effect. In short, this is because banks are only required to hold a portion of your deposits and can lend out the rest, thus artificially creating more money through lending.

Quantitative easing. This is also another form of monetary policy. The central bank “prints” or creates money from thin air. The central bank then purchases long-term securities (e.g. Treasury bonds) on the market. This is basically an injection of capital into the securities market and causes prices of securities to increase. In short, quantitative easing is how the central bank increases money supply by feeding more cash from investors and financial institutions, and letting it trickle down to everyone else.