Money supply
The money supply is the amount of money in an economy. This is superficially straightforward but is complicated by the difficulty of defining what is meant by money.
The simplest possible definition is the actual amount of bank notes and coins in circulation. The problem with this simple definition is that most money exists as bank deposits and other such obligations rather than in physical form.
Measures of money supply
Even the narrowest of the definitions that are actually useful, M0, is broader than physical notes and coins as it includes banks' deposits with the central bank.
The next narrowest measures of money supply are M1 and M2. These add various types of deposits by the private sector with banks and other financial institutions. These are still regarded as narrow measures. They are sometimes referred to as referred to as narrow money.
The broad money measures (M3, M4 and others) add other types of money such as repos, bank acceptances, commercial paper and bonds. Some countries (but not the UK) include foreign currency deposits.
Narrow money measures aim to measure the money supply that is actually held for use in transactions. Broad measures also include money that may be held as a store of wealth. Divisia aggregates weight different types of money, giving a higher weight to those likely to be used for transactions.
There are various variations on these basic types and the exact definitions vary from country to country. The exact definitions are revised from time to time by the Bank of England (or the appropriate central bank).
Money multiplier
The money multiplier (also called the credit multiplier or the deposit multiplier) is a measure of the extent to which the creation of money in the banking system causes the growth in the money supply to exceed growth in the monetary base.
The multiplier is the multiple by which the expansion in the money supply is greater than the increase in the monetary base: if the multiplier is 10, then a £1 increase in the monetary base will cause a £10 increase in the money supply.
Most discussions of the multiplier do not discuss what measure of the money supply is being increased. As it is usually restricted to deposits in banks, this implies that we are talking about M1 (most commonly) or M2. Multipliers can also be calculated for broad money measures such as M3 and M4.
M0 (monetary base)
M0 is the narrowest definition of money supply in common use.
The definition used in the UK is bank notes and coins in circulation, plus banks' deposits with the Bank of England.
M0 is also known as the monetary base. This term refers to the fact that the money measured by M0 supplies the base on which other forms of money (such as bank deposits) are based.
The government is able to control the size of monetary base, and this makes controlling it a key policy issue and an important part of monetary policy.
Governments can increase the monetary base by issuing notes and coins and by issuing money in the form of banks' deposits with the central bank.
money multiplier
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Definition
Mathematical relationship between the monetary base and money supply of an economy. It explains the increase in the amount of cash incirculation generated by the banks' ability to lendmoney out of their depositors' funds. When a bank makes a loan, it 'creates' money because the loan becomes a new deposit from which the borrower can withdrawcash to spend. This money-creating power is based on the fractional reserve system under which banks are required to keep at hand only a portion (between 10 to 15 percent, typically 12 percent) of the depositors' funds. The rest may be converted into loans, thereby increasing the available cash by a factor that is a multiple of the initial deposit.