What it means
Money is easier to define loosely than precisely, so statisticians publish it in layers. Narrow money, often labelled M1, covers notes, coins and balances you can spend immediately.
Broad money adds savings deposits, smaller fixed-term deposits and retail money market fund balances, which are one short step away from being spendable. The wider definition exists because the narrow one behaves erratically.
Households and firms move balances between current and savings accounts for reasons that have nothing to do with spending plans, and every such shift changes narrow money without changing anyone's real purchasing power. Broad money smooths that noise out.
Central banks watch broad money because sustained rapid growth in it has historically accompanied rising inflation, while contraction has accompanied recessions. The relationship is loose rather than mechanical, which is why no major central bank now targets a money supply number directly.
It remains a useful cross-check on whether policy is actually tight or loose. Broad money is created mostly by commercial bank lending rather than by the printing press.
When a bank makes a loan it simultaneously creates a deposit, and when the loan is repaid that deposit disappears, so credit growth and broad money growth move together. Central bank bond buying adds to it as well, by swapping bonds held by non-banks for deposits.
For a business audience the practical reading is about credit conditions. Weak or negative broad money growth usually means banks are lending less, which shows up as tighter working capital facilities and slower customer payments before it appears in official output figures.
Watching it alongside bank lending surveys gives an early sense of where demand is heading.
In practice
Real-world examples.
Example
A pension fund's strategist notes broad money growing at 9% a year against nominal output growth of 5%. She reads the 4 percentage point gap as a sign of building inflationary pressure and shortens the duration of the fund's bond holdings.
Example
During a bond-buying programme a central bank purchases $200,000,000,000 of government bonds from insurers and pension funds. The sellers receive bank deposits in exchange, so broad money rises by roughly the same amount even though no new notes have been printed.
Example
A distributor's finance director sees broad money shrinking for three consecutive quarters. He tightens credit terms with new customers ahead of the slowdown he expects, and negotiates his own facility renewal early while banks are still lending freely.
Formula
Calculation
Formula: broad money = narrow money + savings deposits + small time deposits + retail money market fund balances.
Worked example: In a country reporting in billions of dollars, currency in circulation is $2,300 billion and current account and other cheque-writing balances are $5,200 billion, so narrow money is 2,300 + 5,200 = $7,500 billion.
Savings deposits are $9,000 billion, small time deposits are $1,100 billion and retail money market funds hold $1,400 billion, adding 9,000 + 1,100 + 1,400 = $11,500 billion. Broad money is therefore $7,500 billion + $11,500 billion = $19,000 billion.
A year earlier broad money was $18,100 billion, so annual growth is (19,000 - 18,100) / 18,100 = 900 / 18,100 = 5.0%. With nominal output of $27,000 billion, the velocity of broad money is 27,000 / 19,000 = 1.42, meaning each dollar of broad money supports about $1.42 of annual spending.Case study
Seen in the real world.
Thornbury Components is an illustrative, fictional engineering firm whose finance director began tracking national broad money growth after being caught out by a sudden tightening in bank credit. Her series showed broad money growth slowing from 7% to under 1% over four quarters, while bank lending surveys pointed the same way.
Reading that as a sign that credit was contracting, she renewed Thornbury's $30,000,000 revolving facility nine months early, accepting a margin 0.4 percentage points higher than the previous deal. That is an extra cost of $30,000,000 x 0.4% = $120,000 a year. Six months later two of her competitors were unable to renew similar facilities on any terms.
The fictional point is not that broad money predicts the future. It is that a measure of how much money the banking system is creating gives a business an early and cheap signal about the credit conditions it will face, and acting on it early cost Thornbury far less than being caught short.
Watch out
Common mistakes.
- Assuming broad money is created by central banks printing notes, when most of it is created by commercial banks making loans.
- Reading any rise in broad money as inflation to come, when the link is loose and depends on how fast money changes hands.
- Comparing broad money figures across countries without checking that the underlying definitions match.
Questions
People also ask.
What is the difference between narrow and broad money?
Narrow money covers cash and immediately spendable balances, while broad money adds savings, small time deposits and retail money market funds.
Does broad money shrink when loans are repaid?
Yes, repaying a bank loan cancels the deposit that was created when the loan was made, which reduces the total.
Do central banks target broad money growth?
Not directly any more, because the relationship with inflation proved too unstable, but they still watch it as a cross-check on policy.
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