Money supply: M0, M1, and M2 Different ways of measuring the money supply
Money supply: M0, M1, and M2
- What I want to explore in this video is the different ways of measuring the amount of money we have in circulation.
- So we're going to start things with our Central Bank (in the US, this would be the US Federal Reserve.)
- And let's say that they print $4.
- And we're going to focus just for visualisation purposes, on them doing it phyisically,
- they could also do it electronically, but we're just going to focus on the physical.
- And they way they get this into circulation is that they'll take these four dollars
- and they'll go buy securities in the open market, normally very safe and very liquid securities
- Liquid means it's very easy to buy and sell those securities in large quantities.
- For example, government treasuries is a liquid security or a liquid asset,
- Pez dispensers would not be a liquid asset --
- If i bought a billion dollars worth of pez dispensers
- it would be very hard for me to sell.. one, it would be very hard for me to buy a billion dollars worth
- and it would probably be even harder for me to sell a billion dollars worth
- in any short or medium time frame.
- So the central bank goes out, and let's say they go and buy 1 liquid security for $4,
- [so this is the security right over here]
- and the person they bought the security from decides to deposit it in a bank.
- They could either directly deposit it in a bank or they could use that money
- that they got from selling their security to buy things
- and they person they bought things from could deposit in a bank...
- but one way or another we can imagine it all gets deposited in a bank.
- [So this is our private bank, I'll call this private bank number number 1]
- So now all of these dollars are transferred to PB#1, and they are no longer...
- the Fed Reserve or the central bank (the general case) is no longer in posession of them.
- They've been transferred right over here (to PB #1). [I'm going to cross these out so we can keep track of things.]
- Now, when they deposit in PB#1, they say "well, I need 3 of these dollars on demand
- and I want to write cheques against them."
- So they put $3 in a chequeing account, so they can write cheques up to $3..
- and so they can get a little bit more interest, and the banks will even
- give a little bit more interest on a savings account cos they don't have to keep the reserves;
- they put $1 into a savings account.
- And they cannot write cheques against that savings account
- Now, there are special circumstances, but for simplicity, let's just say that they cannot write cheques
- there are some that have restricted cheque writing and things like that...
- So the banks says "ok, this dollar, I dont have to have
- any reserves against it, and I can loan out this dollar
- and the person they lend it to, let's say they immediately go deposit it into another bank
- so they immediately go and deposit this in private bank 2 (PB#2)
- So it's no longer in PB#1 [Let me draw PB#2... PB#2 is right over here...]
- And they deposit it into a savings account in PB#2
- and let's say that out of all of these
- the bank says "well this is a demand deposit, I have to keep some reserves
- (this is a fractional reserve system)
- but I can lend out -- in the US I can lend out up to 90% of this
- and maybe this bank is a little bit more conservative, and they only lend out two-thirds of these,
- so they lend out 2 out of these 3 dollars.
- And lets say the person they lend out to also happens to deposit it in PB#2, just coincidentally.
- so this $2 also ends up in PB#2, and so they are no longer in PB#1,
- although this person (PB#1) can still write cheques up to $3.
- And here in PB#2, let's say these are deposited in a chequeing account.
- Now, PB#2 can do a couple of things:
- In this chequeing account, it has to keep some reserves,
- let's say its even more conservative, it only decides to lend out half of this
- (even though it could lend out 90%)
- and so it lends out one of these dollars
- and the person they lend it to just takes that dollar and puts it in their wallet.
- They can also lend out this entire savings, and let's just say
- that person that they lend that $1 in savings to also puts it in their wallet.
- Notice, the original $4 is still there..
- Now, and just to be clear, this person (PB#1) right over here can write cheques up to $3,
- and this person over here (PB#2) can write cheques up to $2 [Let me do this in the same chequeing colour]
- Now, let's think about the different forms of money there are here.
- We could think of money in a very, very narrow way, which is 'Just what did the central bank print?'
- or create electronically (as electronic reserves of its member banks' account)
- but for simplicity here, you could just think of the physical currency it printed - it's base money.
- And so that is often referred to as Base Money
- and in the US (and other countries), it's often the same thing as M0...
- (there are slight differences from country to country)
- and in this example, as soon as they printed and put it into circulation...
- (that was $4) we had $4 of base money...
- and that's obvious because as soon as they printed this and bought the security with it
- and it was in circulation, that $4 could be used to buy things,
- it could be used to facilitate transactions.
- Now, that clearly isn't all of the stuff that can be used as money in this little universe we created..
- You have the $4, but these people (PBs) can also write cheques over here...
- so we can have a slightly boarder definition of money
- and over here we will call it M1,
- and here, there's a couple of ways you could think about it
- you could think about it as all of the currenncy that's in people's pockets
- plus all of the cheque-writing capabilities, so if you view it that way
- it would be these $2 plus $5 of cheque-writing capabilities over here.
- So you could have $2 of physical currency that's in people's wallets (not in bank reserves)
- plus the $5 of cheque-wrinting capability, which would give you $7.
- Another way you could view it, is M0 plus cheque-able deposits [I'll just write 'cheques' here]
- but if you do that, you are now double counting
- because some of the M0 is reserves in the cheque-able deposits!
- Or I could just say that some of the cheque-able deposits is held as reserves for M0
- so you would have to subtract out the bank reserves...
- and so then you would get $4..
- cos we don't want to double count these over here... you'd get M0 is $4...
- [I'm gonna do that in white]
- M0 is $4
- The cheque-able deposits is $5..
- [Let me do that in pink.]
- Plus the $5
- and then you would want to subtract out the reserves...
- and the reserves here, there are $2 of the reserves... so minus $2
- and you would get yourself back to the $7.
- The whole point of this is so that you are not double-counting something.
- You are not double-counting this right over here as part of cheque-able deposits and part of the M0,
- you are not using this twice.
- It is both base money and chequeable deposits so we don't want to count it twice.
- The simplest way to think about this is: 'What can be used in this boarder definition to facilitate transactions?'
- These $2 in people's pockets and this ability to write up to $5 of cheques.
- [So that's this view over here]
- and if we want to get even boarder than that, we can get to something called M2
- And here we could say, what is immediately usable to facilitate transactions right now,
- so that would be our $7 of M1, plus things that can be easiliy converted to M1.
- For example, these savings account can be easily converted to chequeing accounts
- it might only take a couple of days (there might be resrictions) but it can be converted
- and when it get converted, it will change the bank's reserve requirements a little bit, but it will allow
- .. if this person converts it.. they will have the ability to write more cheques
- so M2 includes M1 plus things that are very easy to convert to M1,
- so they will include savings accounts, money-market accounts (which I won't go into detail here,
- but they are really kind of similar that you get slightly higher interest but there are restrictions
- on your ability to access it, but it is not too hard to turn it into chequing accounts...)
- and things like small dollar-value time-deposit accounts.
- But for the sake of simplicity in this example, it would be the saving accounts...
- so it will be our $7 of M1, plus the $2 of savings account over here.
- So this is just to give you a picture:
- when someone talks about the money supply, you really have to say, 'what are you talking about?'
- The most typical one is that you are talking about M1,
- because this is the stuff that is directly usable to facilitate transactions.
- Things like the ability to write a cheque or dollar bills in someone's wallet.
- But they might be talking about base money...
- (M0, narrow money are all ways of referring to the same thing especially in the Unites Sates)
- or they might be referring to something even boarder
- and there are boarder definitions even than M2, although M3, they've stopped reporting about it
- but M3 would have things that are a little bit further from being true money,
- from being a chequing account, but they are already fairly liquid
- so they will include other types of assets,
- but the Fed has already stopped reporting this in the recent past,
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