In: Categories » Legal and finance » Stocks and mutual funds » Monetary Aggregates
| Monetary aggregates measure the money stock, which is defined as the sum of highly liquid assets that serve either as a medium of exchange, standard of value, or a store of value. Money supply measures in terms of monetary aggregates are necessary because many assets serve the same purpose as currency; for example, checking accounts, savings accounts, etc. Therefore, operational measures of the money stock must take these assets into consideration. In the United States the monetary aggregate denoted M1 is the most narrowly defined measure of the money stock, and a broader measure, denoted M2, includes everything in M1 plus additional assets. M3 is even a broader measure, including everything in M1 and M2 and more. M1 includes all the currency not held by the Treasury, Federal Reserve Banks, foreign financial institutions, and commercial banks, plus an array of checkable deposits and travelers’ checks. Currency included in M1 is the currency circulating as a medium of exchange. Commercial bank vault cash is excluded because it is represented in depositors’ accounts, and summing the vault cash with customer checking accounts would be counting those funds twice. The largest share of checkable deposits are called demand deposits, because the bank owes that money to the depositor on demand, without prior notice or other conditions. Bank customers often call these accounts checking accounts. Another checkable account is the negotiable order of withdrawal (NOW) account, an interest-bearing account at thrift institutions that resembles a savings account but has checking privileges. Automatic transfer service (ATS) accounts, which automatically transfer funds from an interest-bearing savings account to a checking account as needed, are also included as checkable deposits in M1, as are Credit Union Share Drafts (CUSDs). Checkable deposits owned by other depository institutions, the U.S. government, foreign banks, and other official institutions are excluded from M1. M1 therefore represents highly liquid assets acceptable as a medium of exchange. Often cash is preferred over checks for small transactions, but for large transactions checks are preferred over cash. M2 includes everything in M1 plus small repurchase agreements (less than $100,000), money market deposit accounts and money market mutual fund accounts when minimum deposits are less than $50,000, and savings and small time deposits (less than $100,000). A repurchase agreement is an arrangement under which a commercial bank sells a government bond to a large depositor and agrees to buy it back at a higher price in the future, overnight in some cases. It is an underhanded means of paying interest, and grew into prominence when regulations forbade interest rate ceilings on checking accounts. Money market deposit accounts and money market mutual fund accounts require high minimum deposits, pay high interest, and allow only checks written above a certain amount, such as $500. M2 does not include deposits held in tax-exempt retirement accounts, or those owned by the federal government, foreign governments, or commercial banks. M2 embraces assets less liquid than the assets included in M1, but assets that can readily be converted into cash. M3 includes everything in M2, but adds large repurchase agreements and time deposits, eurodollar accounts, large time deposits, and money market mutual fund accounts held by institutions. Eurodollar accounts are accounts owned by U.S. residents at foreign branches of U.S. banks worldwide, and all banking offices in Canada and the United Kingdom. An even broader monetary aggregate is L. L includes everything in M3 plus short-term treasury bonds, commercial paper, U.S. savings bonds, and bankers’ acceptances. Commercial paper is an unsecured promise to pay. It is sold at a discount from a face value and matures in a short time, no more than nine months. Bankers’ acceptances, meaning a bank accepts (or guarantees) another firm’s promise to pay, provide short-term financing for commercial trade. M3 and L are less liquid assets than M1 and M2, but they represent readily accessible purchasing power, and are therefore included in the broader definitions of money.
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