What Is Adjusted Money Supply?
Adjusted money supply refers to measures of the total amount of money circulating within an economy that have been modified to account for various factors, such as seasonal fluctuations or changes in the composition and liquidity of different monetary components. This concept falls under the broader field of macroeconomics, where precise measurement of the money supply is crucial for analyzing economic activity and guiding monetary policy. By adjusting raw money supply figures, economists and policymakers aim to gain a clearer, more accurate understanding of the underlying trends in the money stock, which can influence inflation and interest rates.
History and Origin
The measurement of money supply has evolved significantly alongside financial systems. Central banks, like the U.S. Federal Reserve, have been collecting and publishing data on the domestic money supply since their inception, with the Federal Reserve beginning this practice in 1913. These statistics have undergone numerous revisions as financial institutions introduced new types of accounts and financial products, blurring the lines between different categories of money10, 11.
Initially, basic aggregates like M1 and M2 were developed to categorize money based on its liquidity. However, it became evident that seasonal patterns—such as increased spending during holidays or tax seasons—could distort the true month-to-month changes in the money supply. To address this, statistical techniques for seasonal adjustment were integrated into the reporting of money supply figures. For instance, the Federal Reserve regularly publishes "seasonally adjusted" money stock measures to remove predictable variations and reveal underlying trends. Be9yond seasonal adjustments, some economists have proposed more complex "adjusted" measures, such as Divisia monetary aggregates, which weight different components of money based on their degree of "moneyness" or how easily they can be used for transactions. This approach aimed to provide a more economically relevant measure of the money supply compared to simple-sum aggregates, especially as financial innovation continued to reshape how money is held and used.
#8# Key Takeaways
- Adjusted money supply refers to monetary aggregates that have been modified to account for distorting factors, such as seasonal variations.
- These adjustments provide a more accurate representation of the underlying trends in an economy's money stock.
- Central banks, like the Federal Reserve, routinely publish seasonally adjusted money supply data for M1 and M2.
- The concept of adjusted money supply is vital for effective monetary policy formulation and economic forecasting.
- More complex adjustments, such as Divisia aggregates, have been proposed to refine money supply measurement based on liquidity.
Formula and Calculation
While there isn't a single universal "adjusted money supply" formula, the most common form of adjustment applied by central banks is seasonal adjustment. This statistical process removes predictable, recurring seasonal patterns from economic data to reveal the underlying trend. For example, the Federal Reserve constructs seasonally adjusted M1 and M2 by individually adjusting their components (such as currency, demand deposits, savings accounts, small-denomination time deposits, and money market funds) and then summing the adjusted figures.
T7he general idea behind seasonal adjustment is to identify and remove the influence of factors that typically occur at the same time each year (e.g., holiday spending, tax cycles). While the specific algorithms are complex, they typically involve statistical models that analyze historical data to estimate and subtract these regular seasonal effects.
Another conceptual form of "adjustment" involves economically weighted aggregates, such as Divisia indices. Unlike simple-sum aggregates (M1, M2) which treat all components as perfect substitutes, Divisia aggregates assign different weights to components based on their liquidity or "moneyness." Components with higher liquidity (like currency) receive a higher weight than less liquid components (like certificates of deposit). The "formula" for such an aggregate involves a complex weighting scheme derived from economic theory, rather than a simple sum.
Interpreting the Adjusted Money Supply
Interpreting the adjusted money supply involves understanding that its primary purpose is to reveal the true underlying momentum of the monetary aggregates, stripped of temporary or recurring distortions. When looking at seasonally adjusted M1 or M2, for instance, a sustained increase indicates an expansion of available money in the economy, suggesting potential for increased spending, investment, and ultimately, economic growth. Conversely, a contraction in adjusted money supply could signal tighter monetary conditions.
Analysts use adjusted money supply figures to identify significant shifts in monetary trends that might not be apparent in raw, unadjusted data. For example, a surge in unadjusted money supply around a holiday period might simply reflect seasonal spending, but if the adjusted money supply also shows a significant increase, it suggests a more fundamental expansion in the money stock. This distinction is critical for policymakers at a central bank who rely on these indicators to formulate appropriate monetary policy responses.
Hypothetical Example
Consider a hypothetical scenario in which a country's unadjusted M2 money supply shows a sharp increase in December each year due to holiday spending and year-end bonuses. In January, the unadjusted M2 then drops significantly as these temporary funds are spent or re-allocated.
If a policymaker were to only look at the unadjusted figures, they might mistakenly conclude that the economy is undergoing a massive expansion in December followed by a severe contraction in January. However, by using the seasonally adjusted M2, these predictable fluctuations are removed.
For example:
- Unadjusted M2 in December: $10.0 trillion
- Unadjusted M2 in January: $9.5 trillion (a 5% drop)
Now, let's consider the adjusted figures:
- Seasonally Adjusted M2 in December: $9.7 trillion
- Seasonally Adjusted M2 in January: $9.72 trillion (a slight increase)
In this hypothetical case, the seasonally adjusted money supply reveals that, after accounting for typical year-end patterns, the underlying money supply actually grew slightly. This adjusted view provides a more accurate signal for economic analysis and monetary policy decisions.
Practical Applications
Adjusted money supply measures are indispensable tools for economists, financial analysts, and central bankers. One primary application is in the formulation and evaluation of monetary policy. Central banks closely monitor adjusted money supply aggregates to gauge the effectiveness of their actions, such as open market operations or changes to reserve requirements, in influencing the economy. A sustained increase in the adjusted money supply, for instance, might signal that expansionary policies are taking hold, potentially leading to higher gross domestic product and employment.
Furthermore, these adjusted figures are crucial for economic forecasting. Researchers and analysts use trends in adjusted money supply to predict future economic activity, inflation rates, and interest rates. For instance, significant deviations in the growth rate of adjusted M2 have historically been studied for their potential implications for economic output and inflation. Th6e International Monetary Fund (IMF) emphasizes that central banks adjust the supply of money to stabilize prices and output, highlighting the practical importance of these adjusted metrics for achieving macroeconomic goals. IMF - Monetary Policy: Stabilizing Prices and Output.
Limitations and Criticisms
Despite their utility, adjusted money supply measures, particularly the standard seasonally adjusted aggregates, face several limitations and criticisms. One significant challenge arises from the inherent difficulty in precisely defining and measuring "money" in a rapidly evolving financial landscape. Financial innovation, such as the rise of digital payment systems and new forms of deposits, can continuously alter the characteristics of different monetary components, making consistent measurement challenging.
A long-standing criticism, often voiced by economists, is that simple-sum aggregates like M1 and M2, even when seasonally adjusted, may not fully capture the true "moneyness" or transactional utility of their components. Fo5r example, a dollar in a checking account might be used for transactions more frequently than a dollar in a less liquid savings account, yet both contribute equally to the simple sum of M1 or M2. This has led some to advocate for more sophisticated, theoretically derived "adjusted" measures, such as Divisia aggregates, which assign weights to different components based on their liquidity and how frequently they are used for transactions. The Cato Institute, for instance, has highlighted the limitations of the Federal Reserve's current money supply measures, arguing that broader, more inclusive, and appropriately weighted metrics are needed for a complete economic picture Cato Institute - The Fed's Misleading Money Supply Measures.
Another limitation is the weakening, and at times, inconsistent relationship between money supply growth and key economic variables like inflation or gross domestic product since the early 2000s. This has led some economists and central banks to rely less on money supply targets and more on direct interest rates adjustments in their monetary policy frameworks. Th3, 4e ability of banks to hold large amounts of excess reserves, for example, can also weaken the link between changes in the monetary base and the broader money supply, making it harder to control the latter effectively.
#1, 2# Adjusted Money Supply vs. Money Supply
The distinction between "adjusted money supply" and "money supply" primarily lies in the statistical treatment applied to the data. "Money supply" generally refers to the raw, unadjusted figures of monetary aggregates like M0, M1, M2, and historically M3, which are simple sums of various liquid assets circulating in the economy. These raw figures represent the total amount of currency and deposits at a given point in time.
"Adjusted money supply," on the other hand, refers to these same monetary aggregates after they have undergone statistical adjustments, most commonly for seasonal variations. The purpose of these adjustments is to remove regular, predictable fluctuations that occur at specific times of the year (e.g., holiday spending, tax cycles) from the data. While the unadjusted money supply provides a snapshot of the total amount of money, the adjusted money supply offers a clearer picture of the underlying trend in economic activity by smoothing out temporary noise. Therefore, adjusted figures are typically preferred for long-term economic analysis and the formulation of monetary policy.
FAQs
What does "seasonally adjusted" mean for money supply?
"Seasonally adjusted" means that statistical techniques have been applied to the raw money supply data to remove the predictable effects of recurring seasonal events. This helps economists and policymakers see the true underlying trends in the money supply, free from the influence of factors like holiday spending or tax seasons.
Why is an adjusted money supply important?
An adjusted money supply is important because it provides a more accurate and stable measure of the amount of money available in an economy. This clarity helps central banks make better decisions regarding monetary policy, such as setting interest rates or conducting open market operations, as it removes misleading short-term fluctuations that are not indicative of fundamental economic shifts.
Is the adjusted money supply always increasing?
No, the adjusted money supply does not always increase. While central banks may aim for stable economic growth that often involves a growing money supply, the adjusted money supply can also decline, particularly during periods of economic contraction or when a central bank implements contractionary policies to combat high inflation.
How often is adjusted money supply data released?
In the United States, the Federal Reserve Board releases weekly money stock measures, including seasonally adjusted M1 and M2, as part of its H.6 statistical release. These releases provide up-to-date information for analysts and the public.