Daily investing, in my opinion, frequently contains news items like “the central bank releases water” and “money easing,” which actually allude to the central bank’s control over the amount of money in circulation.
The availability of money is a crucial economic indicator. We can comprehend the direction of economic change by tracking its changes.
What are the indications and what is the money supply?
Simply put, the money supply is the entire amount of money in circulation.
Time deposits are less liquid than demand deposits, and demand deposits are less liquid than cash, according to various market measures of currency liquidity. The money supply is typically divided into M0, M1, and M2 levels.
M0 is also known as “cash,” which refers to the money that is in circulation outside of the banking system, including the cash that individuals and businesses have on hand. The base currency, which makes up this portion of the money, is the most liquid.
Cash (M0) that is in circulation outside of the banking system and demand deposits held by banks make up M1, often known as “narrow currency.” Demand deposits may be withdrawn and used at any time, and the liquidity is still quite strong even while they are not in the possession of individuals or businesses. M1 is the unit that most directly affects the market and economy since it represents the market’s actual purchasing power. M1 is frequently used as the primary gauge for managing a nation’s money supply.
Wide money supply, or M2, commonly referred to as “broad money,” includes commercial bank time deposits in addition to demand deposits and cash in circulation in the market. Fixed deposits, which represent potential future purchasing power, cannot be withdrawn at any time and have a relatively low level of liquidity (M2). Typically, people’ current deposits are included in M1, but savings, which are essentially unavailable at any moment, are what constitute the national survival period and are therefore included in M2.
It is possible to derive the following fundamental inferences from the information in M0, M1, and M2.
- When M0 increases, people tend to have more money on hand, grow wealthier, and engage in greater consumption, all of which contribute to an expanding economy.
- When M1 increases, it indicates that businesses are actively engaging in production, more money is pouring into transactions and production, and the economy is generally growing.
- As M2 increases, the economy tends to weaken because it comprises time deposits, which restrict the amount of money available in the market and lower transactions and consumption. As a result, it is impossible to interpret the economic trend in isolation and it must be examined in conjunction with other elements.
- When the growth rate of M1 exceeds that of M2, this indicates that businesses are investing more money in transactions and production in order to reap bigger rewards. Market activity is also indicated by the fact that demand deposits of businesses are growing faster than time deposits.
- When the growth rate of M2 is higher than that of M1, this indicates that corporate time deposits are more popular than demand deposits, indicating that there are fewer lucrative opportunities or sources of income in the market. As a result, businesses and residents are more inclined to deposit money in banks in order to secure a stable source of income, and funds gradually settle. Economic growth slowed as a result.