Money Supply

The Money Supply is the sum of all money in particular country. Before going into details we need to define what is money. For thousands of years the mankind has been using commodity money, most notably silver and gold. However most world countries use fiat currencies now. The fiat money supply includes paper bills, coins, and demand deposits. Money supply is measured in several different ways depending on what exactly is considered to be money.

Money Aggregates

Every country has its own ways to measure money supply, but in general there are several money aggregates used throughout the world. In our example we'll use the US monetary aggregates.

M1 M1 is the narrowest measure of money, which includes physical currency and demand deposits.

M2 M2 is a broader measure of money, which everything already included in M1 plus time deposits, savings deposits, non-institutional money-market funds and small CODs.

M3 M3 is even broader measure of money, which includes M2 plus large savings and time deposits (over $100K) and institutional money-market mutual funds.

Money Supply Control

In a fractional-reserve banking system the money supply is controlled through managing short-term interest rates. The interest rates are usually managed by the country's central bank. When the central bank increases interest rates, it becomes more expensive to borrow, and less money is created through loans, which in turn slows the growth in money supply or decreases it (the money supply shrinks when more loans funds are repaid, than borrowed). The opposite is also true when interest rates trend down, borrowing increases, and new money created through loans are added to the economy.

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