Monetary Aggregates: Definition and Example

What Are Monetary Aggregates?

Monetary aggregates are the various measurements of the money supply in an economy. In the United States, they are used to evaluate the economic health and stability of the nation. In addition, the Federal Reserve uses them to implement its monetary policy.

In the U.S., the monetary aggregates are labeled as:

• M0: Paper money and coin currency in circulation, plus bank reserves held by the central bank; it’s also known as the monetary base
• M1: Currency held by the public and transaction deposits (such as checking account balances) at U.S. depository institutions and foreign bank branches operating in the U.S., plus traveler’s checks
• M2: All of M1, plus money market shares and savings deposits (in amounts of less than $100,000)

A legacy aggregate known as M3, which is all of M2 plus large time deposits over $100,000 and institutional money market funds, repo agreements, and large liquid assets, has not been tracked by the Federal Reserve since 2006 but is still calculated by some analysts.

Understanding Monetary Aggregates

The monetary base, or M0, is a monetary aggregate that is not widely observed and differs from the money supply but is nonetheless very important.

It includes the total supply of currency in circulation in addition to the stored portion of commercial bank reserves within the central bank. This is sometimes known as high-powered money (HPM) since it can be multiplied through the process of fractional reserve banking.

M1 is a narrow measure of the money supply that includes physical currency, demand deposits, traveler’s checks, and other checkable deposits.

M2 is a calculation of the money supply that includes all elements of M1 as well as “near money.” Near money refers to savings deposits, money market securities, mutual funds, and other time deposits.

These assets are less liquid than M1 and not as suitable as exchange mediums, but they can be converted into cash or checking deposits quickly.

How They’re Used

The Federal Reserve (Fed) uses monetary aggregates as a metric for how open-market operations, such as trading in Treasury securities or changing the discount rate, affect the economy.

Investors and economists observe the aggregates closely to try to predict actions that the Fed might take. They also watch them because they offer a more accurate depiction of the actual size of a country’s working money supply.

By reviewing weekly reports of M1 and M2 data, investors can measure the monetary aggregates’ rate of change and monetary velocity overall. That knowledge may provide an idea of whether the Fed might raise or lower interest rates.

The Impact of Monetary Aggregates

Studying monetary aggregates can generate substantial information on the financial stability and overall health of a country. For example, monetary aggregates that grow too rapidly may raise concern for an increase in inflation.

If there is a greater amount of money in circulation than what is needed to pay for the same amount of goods and services, prices are likely to rise. If inflation increases substantially, central banking groups may be forced to raise interest rates or stop the growth in the money supply.

For decades, monetary aggregates were essential for understanding a nation’s economy and were key in establishing central banking policies in general. The past few decades have revealed that there is less of a connection between fluctuations in the money supply and significant metrics such as inflation, gross domestic product (GDP), and unemployment.

The amount of money that the Fed releases into the economy is a clear indicator of the central bank’s monetary policy. When compared with GDP growth, M2 is still a useful indicator of potential inflation.

Example

Since 2022, the U.S. money supply has experienced a reduction greater than any seen since World War II.

Reductions in the money supply aren’t common. When they occur, they can be a sign of problems to come related to economic growth, employment, and inflation.

In fact, an M2 that isn’t growing could presage a recession, a growth in unemployment, and deflation. However, GDP growth in the fourth quarter of 2023 increased by 3.2%, a figure that surpassed expectations. This was seen as good news for the economy by the Biden administration.

The Bottom Line

Monetary aggregates are measurements of a nation’s money supply. In the U.S., the money aggregates studied are the monetary base (or M0), M1, and M2.

Monetary aggregates can provide insight into the economic health and well-being of a nation and the stability of its financial markets.

Correction—July 20, 2024: This article has been corrected to state that the M1 monetary aggregate contains currency held by the public and transaction deposits at U.S. depository institutions and foreign bank branches operating in the U.S., plus traveler’s checks.