Broad money, simply put, is a measure of the money supply. It is denoted as M2 (or M3) and can absorb income and spending shocks. Therefore, it satisfies the cautious demand motive as well. Moreover, due to the growing importance in the distribution of wealth, it also functions as a store of value.
Narrow money, as the name suggests, offers a restricted or narrow view of currency circulation in the country. M2 widens the perspective and includes additional components that are otherwise not part of M0 and M1, such as money market funds. Broad money growth, therefore, indicates growth in money circulation in the economy. The total currency and transaction deposit the general public holds with depository institutions. They are institutions that obtain funds predominantly from deposits made by the public, such as commercial banks, savings banks, savings and loan associations, credit unions, etc.
- The Bank of England uses four measures of money – M0, M2, M4, and M3H, where M0 is the narrowest, and M4 is the broadest.
- The narrow money supply only contains the most liquid financial assets.
- This typically includes funds paid using either debit card transactions or a variety of checks.
- M1, M2, and M3 refer to different measures of money supply.
- Broad money is a monetary aggregate that includes deposits with an agreed term of up to two years and deposits redeemable with up to three months’ notice.
Narrow money, also known as M0 and M1, refers to the most liquid forms of money, including physical currency and demand deposits. It represents the basic medium of exchange in an economy, unlike other money categories, such as M2 and M3, that include less liquid assets, such as long-term deposits. The narrow money supply only contains the most liquid financial assets.
M3 is called Broad money as along with liquid deposits it also includes time deposits thus making it a broad classification of Money. M2 Involves all the currencies in circulation and are financial assets used as means of exchange. They possess value when stored and have the capacity to absorb income and spending shocks. The meanings vary depending on the context in which we use the term. However, we might also use it when referring to just to the least liquid forms of money.
Broad Money vs Narrow Money
The difference between broad money refers to a financial instrument’s big and small denominations is the perspective of the inclusion or exclusion of the instrument from M3. One considers it along with the position of the financial instrument within the money hierarchy. It may not include financial instruments with larger significant denominations. However, based on local conditions, limits may differ in actual practice. According to the Bank of England, in the UK, broad money refers to the M4 money supply.
Different countries define their measurements of money in slightly different ways. In academic settings, the term broad money is used to avoid misinterpretation. In most cases, broad money means the same as M2, while M0 and M1 usually refer to narrow money. Broad money is at the heart of the monetary transmission mechanism and consequently plays an important role in the assessment of inflationary pressures. This article examines the factors behind stronger broad money and credit growth in 1995, using recent econometric research undertaken at the Bank.
Narrow Money and Broad Money
The term, which usually refers to M3, includes more than simply banknotes and coins. In other words, it means more than ‘narrow money.’ It is the most inclusive definition of the money supply. The term also includes bank money and any cash held in easily accessible accounts. Bank money refers to demand deposits at commercial banks. Broad Money and Narrow Money are two measures of money supply used in economics to capture the different forms of money in an economy. These measures are important in analysing the overall health of an economy and for understanding the effectiveness of monetary policy.
This category of money is considered to be the most readily available for transactions and commerce. In the United States, narrow money is classified as M1 (M0 + demand accounts). In the United Kingdom, the narrowest measure of money is notes and coins in circulation. The gradations are presented in decreasing order of fluidity. M1 has the highest liquidity and is the easiest to deal with, whilst M4 has the least.
By Ryland Thomas of the Bank’s Monetary Assessment and Strategy Division.
In the U.S., as of July 2024, the M1 money stock is $18.05 trillion and the M2 money stock is $21.05 trillion. The fractional banking system’s money multiplier is an important factor. To know about the different monetary systems in the economy, refer to the linked article. Generally, the interest-earning components progressively create higher-ordered aggregates to have larger yields. This is parallel to the interest-earning components that create lower-ordered aggregates.
The money supply in the economy can be influenced by the Central Bank of the country. The money supply can be increased in an economy by purchasing government securities such as treasury bills and government bonds. Though the size of post office saving accounts is negligible M2 term is used as all the deposits in M2 are not liquid. The record of the total money supply is kept by the Central Bank of the country. The change in the supply of money in an economy can affect the price level of securities, inflation, rates of exchange, business policies, etc. Economists have found close links between money supply, inflation, and interest rates.
According to recent Reserve Bank of India data, the uncertainty caused by the Covid-19 pandemic has led to a surge in the money supply. Know in detail about the Reserve Bank of India – RBI on the linked page. The currency held by the public increased by 8.2% since March-end 2020 and the savings and current account deposits decreased by 8%. Broad money and narrow money are two measures of money supply used in economics. Know all about the Difference Between Broad Money and Narrow Money & Definition, Types & Formula for UPSC Exam. The name is derived from the fact that M0 and M1 are the narrowest or most restrictive forms of money that are the basis for the medium of exchange within an economy.
