What Is Broad Money?
Broad money is a category for measuring the amount of money circulating in an economy. It is defined as the most inclusive method of calculating a given country’s money supply, and includes narrow money along with other assets that can be easily converted into cash to buy goods and services.
- Broad money is the most flexible method for measuring an economy’s money supply, accounting for cash and other assets easily converted into currency.
- The formula for calculating money supply varies from country to country, so the term broad money is always defined to avoid misinterpretation.
- Central banks tend to keep tabs on broad money growth to help forecast inflation.
Understanding Broad Money
Because cash can be exchanged for many kinds of financial instruments, it is not a simple task for economists to define how much money is circulating in the economy. Money supply is measured in different ways. Economists use a capital letter “M” followed by a number to refer to the measurement they are using in a given context.
The formula for calculating money supply varies from country to country. Broad money is the broadest measure, encompassing narrow money (such as cash and checkable deposits), along with less liquid assets such as certificates of deposit, foreign currencies, money market accounts, marketable securities, Treasury bills and anything else that can be easily converted into cash (but not including company shares).
Example of Broad Money
These measurements vary according to the liquidity of the accounts included. M0 typically includes only the most liquid instruments, such as coins and notes in circulation. At the other end of the scale is M3, which is categorized as the broadest measurement of money.
Different countries define their measurements of money in slightly different ways. In academic settings, the term broad money is used to avoid misinterpretation. In most cases, broad money means the same as M3, while M0 and M1 usually refer to narrow money.
The Federal Reserve tracks M1 and M2 money supply. M1 is defined as currency in the hands of the public, travelers checks, demand deposits and checking deposits. M2 includes M1 plus savings accounts, money market mutual funds and time deposits under $100,000.1
Benefits of Broad Money
Widening the scope of the total money in circulation comes with several advantages. Above all, it helps policymakers to better grasp potential inflationary trends. Central banks often look at broad money, alongside narrow money, to set monetary policy.
Economists have found close links between money supply, inflation and interest rates. Central banks such as the Federal Reserve use lower interest rates to increase the money supply when the goal is to stimulate the economy. Conversely, in an inflationary setting, interest rates are raised and the money supply diminishes, leading to lower prices.
In simple terms, if there is more money available, the economy tends to accelerate because businesses have easy access to financing. If there is less money in the system, the economy slows and prices may drop or stall. In this context, broad money is one of the measures that central bankers use to determine what interventions, if any, they could introduce to influence the economy.
Compete Risk Free with $100,000 in Virtual Cash
Put your trading skills to the test with our FREE Stock Simulator. Compete with thousands of Investopedia traders and trade your way to the top! Submit trades in a virtual environment before you start risking your own money. Practice trading strategies so that when you’re ready to enter the real market, you’ve had the practice you need. Try our Stock Simulator today >>« Back to Glossary Index