Money in Circulation
In the United States, the Federal Reserve System and its twelve central banks are responsible for the circulation of money. In most other countries, a single central bank controls the amount of money in circulation. In Europe, the European System of Central Banks controls the money supply for the countries that belong to the European Union. In this unit, we will discuss the most common measures of our money supply, which include the Monetary Base, M-1, M-2, and M-3. Of these, M-1 and M-2 are by far the most frequently used.
The Monetary Base
The Monetary Base, or so-called high powered money, consists of primarily two things: currency in the hands of the non-bank public and bank reserves. Bank reserves include physical and electronically recorded cash balances held by banks. Currency consists of banknotes (paper money) issued through the Federal Reserve, and coins minted by the United States Mint (part of the United States Treasury).
The monetary base is not the same as what economists refer to as the money supply. The monetary base includes funds held by banks. This money does not necessarily get spent on the purchases of goods and services (especially if the money does not get loaned out) and therefore does not necessarily affect economic activity. The money supply measures described in the next paragraphs more directly affect economic activity, because they include funds held by the public (households and non-bank businesses). There are three money supply measures; the first two are most commonly monitored and manipulated by the Federal Reserve for policy decision-making purposes.
Official United States Money Supply Measures
The three official money supply measures in the United States are
M-1 includes all coins and currency in circulation with the public + money in checking or transactions accounts (demand deposits, NOW accounts, and other checkable deposits) + traveler’s checks and money orders. As of April 2020 other checkable deposits also includes regular savings accounts.
A characteristic of M-1 is that it includes money, which you can easily use to purchase goods and services. It, therefore, directly affects economic activity. Credit card payments and balances are not included in M-1. When you pay by credit card, you are borrowing money, and not actually paying for the item you purchased. The money from your transactions account that you use to pay your credit card balance (or part of it) at the end of each month is included in M-1. The amount of money in M-1 (seasonally adjusted) has increased quite a bit over the years. It was $140 billion in 1960 and in 2014 it was $2.6 trillion ($2,600 billion). In February 2020 it was approximately $4 trillion and, three months later, in May of 2020, it was more than $16 trillion. Most of this increase was because of the addition of savings accounts to the definition of M1 so it is difficult to compare these statistics. Without savings accounts, M1 would have been around $5 trillion in May of 2020. Since May 2020 M1 has increased by an additional $5 trillion. These are significant increases and explain the recent increases in the inflation rate.
M-2 includes everything in M-1 + savings deposits (amounts less than $100,000) + money market mutual funds + money market deposit accounts + other short-term money market investments. Government policy-makers have shifted their focus on M-2 instead of M-1 for monetary policy decision-making. The deregulation of the banking industry has made the components in M-2 more liquid, and more people use funds within M-2 to purchase goods and services. M-2 (seasonally adjusted) has increased considerably over the years. It was approximately $300 billion in 1960. In 2014 it was approximately $11,000 billion ($11 trillion) in November of 2018 it grew to $14,318 billion. In November 2022 it exceeded $22 trillion.
M-3 includes everything in M-2 + Large Time Deposits + Repurchase Agreement (RPs) + Eurodollars + Institution-held Money Market Mutual Funds.
Large time deposits are savings accounts with more than $100,000 in each account. Repurchase agreements are forms of savings with collateral (using Treasury securities) backing the loan. Eurodollars are dollar-denominated savings in foreign banks. Institution-held money market mutual funds are savings accounts with a high interest rate held by financial institutions, retirement companies, and insurance companies. The additional forms of money in M-3 are less liquid (not easily exchanged for cash) than the forms of money in M-1 and M-2. M-3 statistics are not followed as closely by economists as M-1 and M-2. Consequently, the Federal Reserve has recently stopped publishing data on M-3.
For a video explanation of the three main money supply measures please watch:
For the latest data on M-1 and M-2 for the past 24 months, please click HERE.