Money supply

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Money supply, a macroeconomic concept, is the quantity of money available within the economy to purchase goods and services. Because (in principle) money is anything that can be used in settlement of a debt, there are varying measures of money supply. The narrowest (ie. more restrictive) measures count only those forms of money held for immediate transactions.

Broader measures include money held as a store of value. Different measures of money have different technical definitions. The most common measures are named M0, M1, M2, and M3 (from narrow to broadly defined). In the United States, these are defined as follows:

M0: The total of all paper cash in circulation.
M1: M0 plus the amount in checking or demand deposit accounts
M2: M1 plus other various savings account types, money market acounts, and certificate of deposit accounts (CDs) of under $100,000.
M3: M2 plus all other CDs and eurodollars held by the US.

Money supply is important because it is directly linked to inflation by the simple equation:

 velocity * money supply = real GDP * GDP deflator

where:

velocity = the number of times per year that money changes hands

GDP (Gross Domestic Product) deflator = measure of inflation

In other words, if the money supply grows faster than real GDP, inflation must follow as velocity has been shown to be relatively stable.

As of about the year 2000, the M1 money supply was about 1.3 trillion dollars, the M2 was $5.4 trillion, and the M3 was $7.8 trillion. If you split all of the money equally per person in the United States, each person would end up with about 26,000.

The amount of actual physical cash was about half a trillion as of the year 2000. To put this in perspective, if everyone who was part of the largest US bank Citigroup tried to liquidate all of their assests from there, there would not be enough cash.

One of the principal jobs of central banks (such as the US Federal Reserve Bank, the Bank of England and the European Central Bank) is to keep money supply growth in line with real GDP growth. Central banks do this primarily by applying pressure to interest rates through open market operations.

A very common criticism of this policy, originating with the creators of GDP as a measure, is that "real GDP growth" is in fact meaningless, and since GDP can grow for many reasons including manmade disasters and crises, is not correlated with any known means of measuring well-being. This use of the GDP figures is considered by its own creators to be an abuse, and dangerous. The most common solution proposed by such critics is that money supply (which determines the value of all financial capital, ultimately, by diluting it) should be kept in line with some more ecological and social and human means of measuring well-being. In theory, money supply would expand when well-being is improving, and contract when well-being is decreasing, giving all parties in the economy a direct interest in improving well-being.

This argument must be balanced against the near-dogma among economists, that the control of inflation is the main (or only) job of a central bank, and that any introduction of non-financial means of measuring well-being has an inevitable domino effect of increasing government spending and diluting capital and the rewards of gainfully employing capital.

Currency integration is thought by some economists -- Robert Mundell, for example -- to alleviate this problem by ensuring that currencies become less competitive in the commodity markets, and that a wider political base be employed in the setting of currency and inflation and well-being policy. This thinking is in part the basis of the Euro currency integration in the European Union.

Money supply remains one of the most controversial aspects of economics itself.