Monetare aggregate

What Is Monetary Aggregates?

Monetary aggregates are formal measures of the total quantity of money circulating within an economy, serving as critical indicators for Monetary Policy and forming a key part of the broader field of Macroeconomics. These aggregates categorize different forms of money based on their Liquidity, ranging from highly liquid assets like currency to less liquid forms such as certain types of deposits. Central banks meticulously track monetary aggregates to gauge the overall availability of money and credit, which directly influences economic activity, Inflation, and Interest Rates. The primary monetary aggregates typically include M1, M2, and M3, each encompassing a progressively broader set of financial assets.

History and Origin

The concept and measurement of monetary aggregates evolved significantly with the increasing complexity of financial systems and the development of modern central banking. Early economists recognized the importance of the quantity of money in an economy, but formal, standardized measures began to emerge more prominently in the 20th century. In the United States, for instance, the Federal Reserve Board began publishing monthly data on currency and demand deposits in 1944, which eventually formed the basis for M1. The Federal Reserve's interest in monetary statistics was sparked, in part, by figures like Marriner Eccles and Lauchlin Currie, and by 1971, the Board started reporting data for additional aggregates, including M2 and M3, reflecting a growing importance of these measures in monetary policy formulation.¹⁶

Over time, definitions of monetary aggregates have been refined and updated to reflect changes in financial instruments and banking practices. A significant redefinition of U.S. monetary aggregates occurred in May 2020, for example, to account for changes in the financial landscape.¹⁵ Similarly, central banks in other regions, like the European Central Bank (ECB), have developed harmonized definitions for their respective monetary aggregates to ensure consistent measurement across the euro area.¹⁴

Key Takeaways

• Monetary aggregates classify the total amount of money in circulation within an economy based on their liquidity.
• The most common aggregates are M1 (narrow money), M2 (intermediate money), and M3 (broad money), each building upon the previous one.
• Central Bank authorities, such as the Federal Reserve and the European Central Bank, compile and monitor these aggregates as key indicators for monetary policy decisions.
• Changes in monetary aggregates can provide insights into potential future economic conditions, including inflationary pressures and Economic Growth.
• While historically central to policy, the relationship between monetary aggregates and macroeconomic variables has become less stable, leading to varied emphasis on their use.

Formula and Calculation

Monetary aggregates are not calculated using a single, overarching formula, but rather are defined as the sum of specific financial assets grouped by their level of liquidity. Each aggregate builds upon the narrower ones. Below are the common definitions as used by many central banks, though specific components can vary slightly by jurisdiction (e.g., U.S. Federal Reserve, European Central Bank).

M1 (Narrow Money)

M1 represents the most liquid forms of money.
$M1 = \text{Currency in Circulation} + \text{Demand Deposits} + \text{Other Checkable Deposits}$

• Currency in Circulation: Physical banknotes and coins held by the public.
• Demand Deposits: Funds held in checking accounts that can be withdrawn or transferred immediately without prior notice.
• Other Checkable Deposits: Includes Negotiable Order of Withdrawal (NOW) accounts, Automatic Transfer Service (ATS) accounts, and credit union share draft accounts.

M2 (Intermediate Money)

M2 includes all of M1 plus certain less liquid assets that can be easily converted into cash or used for payments.
$M2 = M1 + \text{Savings Deposits} + \text{Small-Denomination Time Deposits} + \text{Retail Money Market Funds}$

• Savings Deposits: Interest-bearing accounts that typically do not allow for direct check writing but are easily accessible.
• Time Deposits (Small-Denomination): Certificates of Deposit (CDs) held in amounts less than $100,000, with a specified maturity date.
• Money Market Funds (Retail): Shares in money market mutual funds held by individuals.

M3 (Broad Money)

M3 is the broadest aggregate, encompassing M2 plus larger, less liquid financial assets.
$M3 = M2 + \text{Large-Denomination Time Deposits} + \text{Institutional Money Market Funds} + \text{Repurchase Agreements} + \text{Eurodollars}$

• Large-Denomination Time Deposits: Time deposits in amounts of $100,000 or more.
• Institutional Money Market Funds: Shares in money market mutual funds held by institutions.
• Repurchase Agreements (Repos): Short-term borrowing for dealers in government securities.
• Eurodollars: Dollar-denominated deposits held in foreign banks or foreign branches of U.S. banks.

Note: In 2006, the Federal Reserve discontinued publishing M3 due to its judgment that it did not provide additional useful information for monetary policy beyond M2.¹³ However, the European Central Bank and other central banks continue to use and publish M3.¹²

Interpreting the Monetary Aggregates

Interpreting monetary aggregates involves analyzing their growth rates and composition to understand the availability of liquidity in the financial system and potential implications for the economy. Rapid growth in aggregates like M2 or M3 might signal future inflationary pressures, as "too much money chasing too few goods" can lead to rising prices. Conversely, slow or negative growth could indicate a tightening of credit conditions, potentially hindering Economic Growth and leading to deflationary concerns.

Central banks, such as the Federal Reserve, routinely monitor these figures. For example, the Federal Reserve's H.6 release provides weekly and monthly data on U.S. money stock measures.¹¹ Analysts look for trends and deviations from historical norms. A surge in M1, comprising the most liquid assets, often reflects increased immediate spending capacity. Broader aggregates like M2 can indicate changes in savings behavior and the willingness of individuals and businesses to hold liquid or near-liquid assets.¹⁰ Policymakers consider these trends alongside other economic indicators, such as Gross Domestic Product and employment figures, to formulate appropriate monetary policy responses.

Hypothetical Example

Consider a hypothetical economy where the central bank is concerned about slowing economic activity. To stimulate the economy, the central bank might implement expansionary Monetary Policy.

Initially, let's assume the economy has the following:

• Currency in Circulation: $500 billion
• Demand Deposits: $1,500 billion
• Other Checkable Deposits: $300 billion
• Savings Deposits: $4,000 billion
• Small-Denomination Time Deposits: $1,000 billion
• Retail Money Market Funds: $800 billion

Based on these figures:

• M1 = $500B (Currency) + $1,500B (Demand Deposits) + $300B (Other Checkable Deposits) = $2,300 billion
• M2 = $2,300B (M1) + $4,000B (Savings Deposits) + $1,000B (Small-Denomination Time Deposits) + $800B (Retail Money Market Funds) = $8,100 billion

Now, suppose the central bank lowers its key Interest Rates and conducts Quantitative Easing. This might lead to banks having more excess reserves, encouraging them to lend more. As a result, businesses and consumers take out more loans, which are deposited into checking accounts.

Let's say after six months:

• Demand Deposits increase by $200 billion to $1,700 billion.
• Savings Deposits increase by $300 billion to $4,300 billion, as some of the new money is saved.

The new monetary aggregates would be:

• New M1 = $500B (Currency) + $1,700B (Demand Deposits) + $300B (Other Checkable Deposits) = $2,500 billion (an increase of $200 billion)
• New M2 = $2,500B (New M1) + $4,300B (New Savings Deposits) + $1,000B (Small-Denomination Time Deposits) + $800B (Retail Money Market Funds) = $8,600 billion (an increase of $500 billion)

This hypothetical increase in monetary aggregates signals that the central bank's actions have increased the money supply, providing more liquidity for transactions and potential investment, which could stimulate economic activity.

Practical Applications

Monetary aggregates are extensively used by economists, financial analysts, and policymakers for various purposes:

• Monetary Policy Formulation: Central banks around the world, including the European Central Bank, consider monetary aggregates as important reference points in their monetary policy strategies. They use these measures to assess the overall liquidity conditions in the economy and their potential impact on price stability and financial stability.⁹,⁸ For instance, if broad money growth accelerates significantly, a central bank might consider tightening monetary policy to curb potential Inflation.
• Economic Forecasting: Analysts often study trends in monetary aggregates to forecast future economic activity, including Gross Domestic Product growth and inflation¹²³⁴⁵⁶