Broader Measure Of Money Supply

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Broader Measure of Money Supply

Although the majority of economists prefer the narrow definition of the money supply (M1) there is a highly influential group which prefers to work with broader measures of money.1

This group stresses the store of value function of money. They have argued that the role of money as a store of value is as important as its role as a means of exchange. They point out that savings and time deposits (hereinafter referred to as time deposits) are included in the measure of money supply. It is maintained that people frequently (and easily) switch from time deposits to currency or demand deposits; and, as a consequence, they consider all bank deposits to be money even though they are unable to make payment using their time deposits.

If we include savings and time deposits with M1, we will get the broad measure of the money supply. This measure of the money supply is usually referred to as M2. Thus,

                      M2 = M1 + Time Deposits
Since           M1 = Currency + Demand Deposits
                      M2 = Currency + Demand Deposits + Time Deposits

Milton Friedman, the world’s foremost monetarist, believes that M2 is the best measure of the money supply (M2 is M1 plus savings and time deposits)2. He argues that time deposits are quite liquid (easily and rapidly converted into M( )); it makes sense to include them in the money supply.

Criticisms of the Broader Measure

The inclusion of time deposits in the measure of money supply provoked a lot of criticism. Clearly, once one violates the medium of exchange criterion and begins to include time deposits it becomes conceptually difficult to draw the line. If convertibility into cash is deposits, it becomes conceptually difficult to draw the line. If convertibility into cash the criterion, we will find that there is a continuum of assets starting form currency notes to real assets. If time deposits were defined as money because they could be easily turned into cash, it might be argued that bonds, mortgaged, treasury bills and other assets should also be called money.

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