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The money supply is the total amount of liquid or near-liquid assets in the economy.
The Federal Reserve, or the Fed, manages the money supply, trying to prevent either recession or serious inflation by changing the amount of money in circulation.
The Fed increases the money supply by buying government bonds in the open market, and decreases the supply by selling these securities.
In addition, the Fed can adjust the reserves that banks must maintain, and increase or decrease the rate at which banks can borrow money. This fluctuation in rates gets passed along to consumers and investors as changes in short-term interest rates.
The money supply is grouped into four classes of assets, called money aggregates. The narrowest, called M1, includes currency and checking deposits. M2 includes M1, plus assets in money market accounts and small time deposits.
M3, also called broad money, includes M2, plus assets in large time deposits, eurodollars, and institution-only money market funds. The biggest group, L, includes M3, plus assets such as private holdings of US savings bonds, short-term US Treasury bills, and commercial paper.
money supplythe stock of MONEY in an economy. The money supply can be specified in a variety of ways: narrow definitions of the money supply include only a limited number of assets, while broader definitions extend the range of assets included; for example, the ‘M0’ (narrow) money supply comprises currency (notes and coins), COMMERCIAL BANKS' till money and their operational balances at the Bank of England; ‘M3’ (broad) money supply is made up of M0 plus sight and time deposits with the commercial banks and UK public sector sterling deposits; and ‘M4’ is made up of M3 plus deposits with the building societies.
The size of the money supply is an important determinant of the level of spending in the economy and its control is a particular concern of MONETARY POLICY. However, the monetary authorities have a problem because given the number of possible definitions of the money supply, it is difficult for them to decide which is the most appropriate money supply category to target for control purposes. Moreover, having targeted a particular definition they face the added difficulty of actually controlling it because of the potential for asset switching from one category of money to another.
For most of the 1980s the authorities targeted M3 for control purposes, but in recent years have switched to M0 and M4 as ‘indicators’ of monetary conditions in setting ‘official’ INTEREST RATES (see MONETARY POLICY COMMITTEE). See LEGAL TENDER.
money supplythe amount of MONEY in circulation in an economy. Money supply can be specified in a variety of ways (see Fig. 127 ), and the total value of money in circulation depends on which definition of the money supply is adopted. ‘Narrow’ definitions of the money supply include only assets possessing ready LIQUIDITY (that is, assets that can be used directly to finance a transaction - for example, notes and coins). ‘Broad’ definitions include other assets that are less liquid but are nonetheless important in underpinning spending (for example, many building society deposits have first to be withdrawn and ‘converted’ into notes and coins before they can be spent).
The size of the money supply is an important determinant of the level of spending in the economy, and its control is a particular concern of MONETARY POLICY. The monetary authorities have a problem, however, because, given the number of possible definitions of the money supply, it is difficult for them to decide which is the most appropriate money supply category to target for control purposes. Moreover, having targeted a particular definition, they face the added difficulty of actually controlling it because of the potential for asset-switching from one category of money to another. For example, if the authorities target M3 (mainly currency plus bank deposits) for control purposes, this may not be sufficient in itself to reduce spending. Spenders may simply use their building society deposits (M4 type money) or national savings (M5 type money) to finance current purchases.
In the 1980s the UK government, as part of its MEDIUM-TERM FINANCIAL STRATEGY, set ‘target bands’ for the growth of, initially, sterling M3 and later M0. In recent years, formal targeting of the money supply has been abandoned, although the authorities have continued to ‘monitor’ M0, together with M4, as ‘indicators’ of general monetary conditions in the economy in setting ‘official’ INTEREST RATES (see MONETARY POLICY COMMITTEE). See LEGAL TENDER.