US: Money Supply


Fri Nov 25 15:30:00 CST 2016

Definition
The monetary aggregates are alternative measures of the money supply by degree of liquidity. Changes in the monetary aggregates indicate the thrust of monetary policy as well as the outlook for economic activity and inflationary pressures. Money supply is in terms of two componentsM1 and M2 (the Fed formerly produced a version called M3 but no longer does so). M1 and M2 are progressively more inclusive measures of money: M1 is included in M2. M1, the more narrowly defined measure, consists of the most liquid forms of money, namely currency and checkable deposits. The non-M1 components of M2 are primarily household holdings of savings deposits, small time deposits, and retail money market mutual funds.

Description
In recent years, the various money supply measures have not mattered to most investors though that has changed somewhat recently. The monetary aggregates (known individually as M1 and M2) used to be all the rage when the Fed did not publicly announce it interest rate target because the data revealed the Fed's (tight or loose) hold on credit conditions in the economy. The Fed in the past issued target ranges for money supply growth at its first report to Congress each year. In the past, if actual growth moved outside those ranges it often was a prelude to an interest rate move from the Fed. Today, the Fed no longer sets money supply targets due to a variety of changes in the financial system and the way the Federal Reserve conducts monetary policy. Monetary policy is understood more clearly by the level of the federal funds rate.

But with the Fed cutting the fed funds rate to essentially zero in December 2008, markets began to look for other ways (other than rate changes) for viewing the progress and impact of quantitative easing and tracking the money supply became one of numerous methods of seeing how the Fed's further injections of liquidity were filtering through the economy.

Importance
This indicator has had low importance during the Fed's publicly announced interest rate targeting period but has gained a little more stature during quantitative easing since the fed funds rate has been at essentially zero.

Interpretation
Money supply is in terms of two componentsM1 and M2 (the Fed formerly produced a version called M3 but no longer does so). M1 and M2 are progressively more inclusive measures of money: M1 is included in M2. M1, the more narrowly defined measure, consists of the most liquid forms of money, namely currency and checkable deposits. The non-M1 components of M2 are primarily household holdings of savings deposits, small time deposits, and retail money market mutual funds. However, both measures are somewhat volatile on a weekly basis and monthly data give a better picture of how much liquidity the Fed has injected into financial markets has been converted into readily spendable forms. During periods of off and on flight to safety by investors and traders, M2 can be quite volatile as funds flow from stocks (other than retail mutual funds) into "cash". Equities outside of mutual funds are not counted as part of M2.