Question Enn Finance & Economics

Monetary aggregates and their role in the economy

Examine money and its relationship to monetary aggregates and their role in the economy and make comparisons with those in the UK

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Answer Internal Staff

Money aggregates are broad categories that measure the money supply in an economy. Money supply measures the amount of money in the economy at a particular time. The two common money aggregates are monetary base and broad money.

• Monetary base (e.g. M0)– notes and coins outside the central bank

• Broad money (e.g. M4) – cash in circulation plus retail and wholesale bank and building society deposits.

In the UK, there are two measures of the money supply: cash in circulation (i.e. outside the Bank of England; in other words, by individuals, firms, banks and the public sector) and M4. The cash in circulation is the ‘monetary base’ or ‘narrow money’. In addition, there is a measure called ‘Retail deposits and cash in M4’ (previously known as M2). This includes the cash in circulation with the private sector (but not cash in banks and building societies) This measure excludes wholesale deposits.

The European Central Bank (ECB) uses three measures which are different from those used by the Bank of England. These are as follows:

M1 – cash in circulation with the public + overnight deposits (this is much broader than UK’s narrow money measure)

M2 – M1+ deposits with agreed maturity up to two years + deposits redeemable up to three months’ notice

M3 – M2+ repos+ money market funds and paper + debt securities (this is much broader than UK’s broadest measure M4)

The U.S. uses the following measures:

M0 – cash in circulation

M1 – M0 + travelers checks and demand deposits

M2 – M1 + money market shares and savings deposits

M3 – time deposits over $100, 00 and institutional funds.

Growth in money supply/money aggregates indicates future economic growth (to a lesser extent) and inflation. If money supply outpaces economic growth, then there will be extra money but the same amount of goods.