Chapter 15: The Money Supply and the Money Multiplier
The amount of "money" that is available to the market is more than the amount of currency that the Federal Reserve Bank has put into circulation, largely because "money" represents the amount of funds a person has access to in various accounts. To draw some distinctions:
- M0 (Monetary Base) - Refers to the number of notes and coins that are outstanding, or the physical money that has been coined/printed
- M1 - Adds to this the amount of money that is available in on-demand accounts (checking and savings)
- M2 - Adds the amount in savings accounts, money market accounts, and short-term time deposits (CDs/Treasuries)
- M3 - Adds the amount that is in longer term time deposits as well as commercial paper
(EN: Note that these are distinctions made in the American market, and other countries include different things in different levels of their money supply.)
Economists use the term "money multiplier" to reflect the ratio of the monetary base to the money supply (such that MB x MM = MS), as this reflects the degree to which the amount of physical money could be increased if all the financial investments were immediately liquidated and the amount withdrawn from every account as cash.
It is expected that this scenario would never happen - people keep their money locked up in accounts and various investments indefinitely, until it is needed. And while some individuals or organizations will experience a shortage or crisis that would cause them to need all of their financial assets in cash, for the most part these balances will remain out of circulation.
As such these numbers are generally important only for bankers who are laying disaster plans for the worst-case scenario (all their depositors cash out at once), which very rarely occurs, as well as to the federal reserve itself in the case of a systemic crisis in which major financial institutions falter and there's a catastrophic run on the banks, requiring a sudden infusion of cash to the system.
It's also noted that the speed at which transactions occur is making the distinction between the M0 and M1 largely moot. These concepts hail from a time in which there was a delay in accessing cash in accounts: to get paper money, a person would need to go to a bank. The widespread use of debit cards means that ordinary people have the ability to access their M1 supply of money instantly and can use that supply of money for everyday transactions. There is an extreme viewpoint that paper money may eventually become extinct and all transactions will be transfers between accounts - which seems farfetched but is a theoretical possibility.
(EN: I've researched this before and as I recall there has been no significant change in the proportion of M0 to M1 in recent decades. If the extreme viewpoint held true, there would be a decrease in M0 and a corresponding increase in M1, but this is not evident. A plausible explanation is that people use debit cards for purchases they would have made with checks or credit cards rather than cash - but at the same time it is undeniable that the Millennial generation prefers card transactions and carries less physical money, but apparently not to a degree that would cause a change in the nature of the money supply.)
The M2 Money Multiplier
Generally, the money multiplier is meant to indicate the difference between hard currency (M0) and the amount available in accounts that can be accessed immediately (M1), but the term is also used between any "level" of money and a higher one - so there is another multiplier between M1 and M2 that tends to be much larger than the M0 to M1 multiplier.
The reason for this is that both M0 and M1 are working capital - it is the money that people (and companies) use to purchase things in the short term, so this amount of money is constantly passing from one hand to the next, and the decrease in one person's supply causes an increase in another's. The M2, meanwhile, represents savings and investments that are set aside - in effect, taken out of the working capital for (distant) future use. Individuals tend to amass savings over time (such as the billions of dollars in pension and retirement funds) and continue to increase their M2 holdings throughout their lives, spending them out only occasionally.
In this sense, the M2 represents individuals' and organizations' capital reserves - it is not money they intend to spend immediately, but money they plan to spend in the distant future (or access in case of emergency). The amount of M2 in a society represents the degree to which members of that society save for the future, but it does not have much impact on the present economic activity. If a person's M2 reserves were wiped out, they would still have the ready cash in M0 and M1 to carry on with their day-to-day economic activities and, so long as they remain productive, their stock of working capital would be preserved and replenished. And because M2 has so little influence on the present economy, it receives very little attention.
The amount of money represented by M2 is significant to bankers, however, because it represents their own capital reserves - money that it is "safe" for them to lend out because the owner of that money is not likely to seek to withdraw it.
(EN: The author doesn't delve into this, but this is where I understand there to be the potential for banks to "create" money. When a loan is made from a person's savings account, the amount of the loan is added to working capital of the borrower, but the same amount remains on the books as being in the person's savings account. The bank may journal the amount from cash to receivables, but it is still included in M2 as if it were there. Hence the money supply is increased without a corresponding increase in the monetary base.)