What it means
Most money is not physical at all, existing instead as digits in bank computer systems, which is why economists count it in tiers. The narrowest tier covers notes, coins and the reserves banks hold at the central bank, the next adds current account balances that can be spent immediately, and the broadest adds savings and small time deposits.
Each tier is progressively less liquid, meaning harder to turn into spending at a moment's notice. The supply grows mainly through bank lending, because writing a loan creates a matching deposit at the same instant.
Central banks steer that process by setting policy rates and by buying or selling government bonds, which changes the reserves banks have available to lend against. For a business, the direction of money supply growth is a useful early read on credit conditions.
Rapid growth usually sits alongside cheap borrowing and easy refinancing, while a shrinking supply tends to arrive with tighter lending standards, slower customer payments and fussier credit committees. The link between money and inflation runs through velocity, which is the number of times each dollar changes hands in a year.
A larger money supply only pushes prices up if that money actually moves, which is why big expansions during a crisis can sit quietly in bank reserves for months without touching the shops. Definitions vary by country, and some central banks have retired measures they no longer find useful.
The practical lesson is to check which measure a commentator is quoting before drawing conclusions, because narrow and broad money can move in opposite directions in the same quarter.
In practice
Real-world examples.
Example
A commercial property developer watches broad money growth slow from 8% to 2% across four quarters. Rather than commit to a land purchase, the team delays the deal by two quarters, expecting lenders to widen margins and demand more equity. The delay saves roughly 90 basis points on the eventual construction facility.
Example
A manufacturer's treasury team sees the money supply contracting and decides not to lock surplus cash into a twelve month deposit. They keep the balance in 90 day instruments instead, so the company can refinance a maturing loan from its own resources if bank credit dries up.
Example
An importer of household goods notices money supply growth running well ahead of output growth and expects consumer prices to follow. The buying team brings forward its next container order by six weeks and fixes supplier pricing for a year, ahead of an anticipated round of cost increases.
Think of it
“Money supply is the total money in the economy-all the money circulating.
Formula
Calculation
M1 = currency in circulation + chequable deposits
M2 = M1 + savings deposits + small time deposits + retail money market funds
Annual growth = (M2 now - M2 a year ago) / M2 a year ago
Suppose currency in circulation is $2,300 billion and chequable deposits are $5,100 billion. M1 = $2,300 billion + $5,100 billion = $7,400 billion. Adding savings deposits of $9,800 billion, small time deposits of $1,200 billion and retail money market funds of $1,600 billion gives M2 = $7,400 + $9,800 + $1,200 + $1,600 = $20,000 billion, or $20 trillion.
If M2 stood at $19,200 billion a year earlier, annual growth = ($20,000 billion - $19,200 billion) / $19,200 billion = $800 billion / $19,200 billion = 4.2%. A finance director who is also seeing 6% wage inflation would read that as money growing more slowly than costs, which usually signals a tightening environment for borrowers.Case study
Seen in the real world.
What follows is an illustrative, entirely fictional scenario. Cedar Ridge Logistics, an invented regional haulage business with $60 million of revenue, financed its fleet almost entirely with three year bank loans that it rolled over as each one matured. Nobody in the finance team had ever looked at a monetary statistic, because it felt like something for economists rather than hauliers.
When broad money growth turned negative for two consecutive quarters, Cedar Ridge's fictional finance director happened to read about it and asked her relationship bank a simple question: would the next rollover be approved on the same terms. The honest answer was no, and the company had four vehicle facilities maturing within eight months.
Acting early, Cedar Ridge agreed a single five year facility while credit was still available, accepting a slightly higher headline rate in exchange for certainty. Two of its competitors, who waited, ended up selling trucks to raise cash when their own rollovers were refused.
Watch out
Common mistakes.
- Treating the money supply as if it were only cash, when the overwhelming majority of it is bank deposits created by lending.
- Assuming that every increase in the money supply produces immediate inflation, ignoring how fast the money is actually being spent.
- Comparing money supply figures across countries without checking that the two measures are defined the same way.
Questions
People also ask.
Who actually creates most of the money in an economy?
Commercial banks do, because each new loan creates a new deposit, while the central bank mainly influences how much of that lending is profitable.
Should a small business owner care about this at all?
Broadly yes, since a sustained slowdown in money growth is one of the earliest warnings that overdrafts and asset finance will get harder to obtain.
Where can these figures be found?
Central banks publish them monthly for free on their statistics pages, usually with several years of history so you can see the trend rather than a single reading.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%