What Is Broad Money?
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. Repurchase agreements, shares or units of money market funds and debt instruments of up to two years also form part of this category.
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Source: Broad Money (wallstreetmojo.com)
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.
- Broad money is a measure of money supply in the economy category of money is denoted by M2 (U.S); it may differ from country to country according to their respective policies.
- The key factors of transaction costs, divisibility, maturity, and yield are crucial in determining if specific forms of financial assets need to be incorporated into this category.
- It contains financial assets that are less liquid than narrow money.
- Broad money growth indicates the increase in money circulation in the economy.
Broad Money Explained
Broad money definition implies a wide range of economic functions. Some of them can be means of exchange, given that they contain transaction balances for buying products and services related to the narrower transaction-based aggregates. Although not exclusively transaction-oriented, several other deposits or financial instruments fall under the “broad money” group. It is because one can swiftly convert them to transaction balances at little to no cost (in terms of time and money).
A broad money supply consists of financial instruments that are liquid and dependable as a store of value and a medium of exchange. Hence they are a close substitute for a medium of exchange. Since wealth management is becoming increasingly important for high savers, the concept of broad money is becoming more and more crucial.
The following basic factors are taken into consideration when identifying the elements of M2 money other than currency and transferable deposits:
#1 – Costs associated with transactions
Some financial asset types require significant transaction fees or delays for conversion. There are, however, deposits and other forms of debt securities that may be converted into money or transferrable deposits. Those without incurring direct costs in the form of fees or other charges or the implicit costs associated with conversion delays belong to this type.
#2 – Divisibility
The difference between 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.
#3 – Maturity
Maturity is a key factor that decides the elements of broad money. In some circumstances, the hierarchy of a group of money aggregates advances from the presence of short-term components to that of longer-term deposits or debt instruments in higher-ordered aggregates.
#4 – Yield
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.
Broad Money Formula
The Federal Reserve website of the U.S. government describes two forms of money supply, M1 and M2. It begins with the foundation or the monetary base. The monetary base is the total amount of currency circulating in the economy and reserve balances. For example, deposits held by banks and other financial institutions at the Federal Reserve come under reserve balances.
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.
This category includes M1 components, saving deposits, time deposits in small denominations (less than $100,000), and retail money market mutual fund shares.
Therefore, one can express it in terms of the following formula:
M2 = M1 + savings deposits + retail money market mutual funds + time deposits + money market deposit accounts.
(M1 encompasses coins and currency in circulation, checkable demand deposits + traveler’s checks, etc.)
Broad Money vs Narrow Money
Narrow money is a category of money supply that is highly liquid. This category includes money, such as coins and banknotes, as well as overnight deposits. Broad money is a category of money supply that encompasses narrow money along with other less liquid supply forms.
Narrow money (M1) is expressed as a seasonally adjusted index based on 2015=100 as the base. Likewise, M2 is quantified using a seasonally adjusted index 2015=100 as the base. However, broad money and narrow money are different in some aspects and are as follows.
#1 – Category
Narrow money is referred to as M0 and M1. Broad money is denoted as M2 and M3 (OECD).
#2 – Liquidity
Narrow money is the most liquid category of money available for immediate transactions. In contrast, M2 contains financial assets that may not come with the option of easy convertibility into cash within a short period.
#3 – Scope
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.
#4 – Examples
Money, which includes banknotes, coins, and overnight deposits, is present in M1. Examples of narrow money are coins and notes in circulation and overnight deposits. Broad money supply includes instruments such as money market fund shares or units and debt securities for up to two years.
Frequently Asked Questions (FAQs)
Components of M2 include M0+M1+ savings deposits, small and large-denomination time deposits, long-term repurchase agreements, money market deposit accounts, retail money market mutual funds, etc.
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. However, it is less liquid than narrow money components.
M2 involves more components than narrow money. Narrow money consists of bills, coins, and bank deposits that can be used for transactions by consumers in normal daily life. It is easily liquefiable as opposed to M2.
Base money is also referred to as the monetary base and is denoted by M0. It consists of bank reserves and money in circulation. On the other hand, broad money is wider and includes financial assets one can liquidate later.
This article has been a guide to What is Broad Money. Here, we explain its definition and formula and compare it with narrow money. You can learn more about it from the following articles –
- Repurchase Agreement
- Liquid Assets
- Fiat Money