Measuring and Manipulating the Money Supply

A key aspect of the economy and fiscal policy involves knowing how much money is in circulation. Money can be loosely defined as the stock of assets used for transactions and consequently, the total stock of assets is the quantity of money. Therefore, if for example, you and you friends decide to trade baseball cards based on a certain number of points assigned to each card, the total number of points available would be the monetary supply.

But measuring the stock of assets in a society like ours if extremely difficult as our investments lie in everything from cash to checks to gold to mutual funds and so on. Consequently, four fairly comprehensive, successive measures (each denoted by a particular symbol) are used to illustrate the monetary supply of a given society. The first is C which is the total legal tender currency in circulation. The second, M1, includes C and all demand deposits, traveler’s checks and other checkable deposits. The third measure is M2, which comprises retail money market mutual fund balances, saving deposits (including money market deposit accounts) and small time deposits all in addition to M1. The final measure, M3, includes M2 and large time deposits, repurchase agreements, Eurodollars, and institution-only money market mutual. As of March 2001 these values were $539 billion, $1.111 trillion, $5.1 trillion and $7.326 trillion respectively.

Most of these measures probable don’t make a lot of sense but these values are vital to the way agencies such as the Federal Reserve, specifically the Federal Open Market Committee, determine monetary policy in the United States. Manipulation of the money supply is primarily achieved through open-market operations which involve the purchase and sale of government bonds. When the Fed wants to decrease the public money supply, it issues government bonds and treasury bills which are often bought as secure investments. This removes money of equivalent value of the bonds from circulation. Likewise, when the public money supply needs to be expanded, the Federal Reserve buys bonds back.

This is a basic overview of the measure and manipulations of the quantity of money in circulation.