Definition / Meaning of Money supply – M3

Money supply M3 is a broad measure of the total amount of money circulating in an economy. It includes all of the components of the narrower M1 and M2 money supply measures, plus large time deposits, institutional money market funds, short-term repurchase agreements (repos), and other larger liquid assets. Essentially, M3 captures the entire stock of money that is available in a country’s financial system, from the cash in your wallet to the large deposits held by corporations and financial institutions.

What is Included in M3?

To understand M3, it helps to look at the building blocks of the money supply. The Federal Reserve (the central bank of the United States) traditionally defined M3 as the sum of:

• M1: The most liquid forms of money, including currency (coins and paper money) held by the public, traveler’s checks, demand deposits (like checking accounts), and other checkable deposits.
• M2: A broader measure that includes everything in M1, plus savings deposits, money market deposit accounts (MMDAs), small-denomination time deposits (CDs under $100,000), and balances in retail money market mutual funds.
• Large Time Deposits: Certificates of deposit (CDs) of $100,000 or more, typically held by institutions.
• Institutional Money Market Funds: Money market funds that are available only to large institutional investors, such as pension funds and corporations.
• Repurchase Agreements (Repos): Short-term loans where one party sells securities to another with an agreement to buy them back later at a slightly higher price. These are often used by banks and large financial institutions to manage short-term cash needs.
• Eurodollars: U.S. dollar-denominated deposits held in banks outside the United States.

Why is M3 Important?

M3 provides a comprehensive view of the total money supply in an economy. Economists and central bankers use it to gauge the overall level of liquidity and to help predict future economic activity, inflation, and interest rates. A rapidly growing M3 can signal that there is a lot of money available for spending and investment, which could lead to higher inflation if the economy is already operating near its full capacity. Conversely, a slow-growing or shrinking M3 might indicate a tightening of credit and a potential economic slowdown.

M3 and the Federal Reserve

It is important to note that the Federal Reserve stopped publishing M3 data in 2006. The Fed stated that the costs of collecting and processing the data outweighed the benefits, as M3 did not appear to provide any additional useful information for conducting monetary policy beyond what was already available from M2 and other financial indicators. However, many other central banks around the world, such as the European Central Bank (ECB) and the Bank of Japan, continue to track and publish M3 as a key economic indicator. Even though the Fed no longer publishes it, economists and analysts still calculate their own estimates of M3 using available data to get a fuller picture of the money supply.

M3 vs. M1 and M2

The key difference between M3 and the narrower measures is the degree of liquidity. Liquidity refers to how easily an asset can be converted into cash without losing its value. M1 is the most liquid, M2 is less liquid than M1 but still relatively liquid, and M3 includes assets that are even less liquid, such as large time deposits and institutional money market funds. Think of it as a set of nesting dolls: M1 is the smallest doll (the most liquid), M2 is a larger doll that contains M1, and M3 is the largest doll that contains both M1 and M2 plus the other less liquid assets.

Example of M3 Components

To make this more concrete, consider the following hypothetical breakdown of the U.S. money supply (in trillions of dollars):

In this example, M3 is $20 trillion, which is $5 trillion larger than M2. This extra $5 trillion represents the large, less liquid deposits and short-term borrowing that are not captured in the narrower measures.

Conclusion

While the Federal Reserve no longer officially tracks M3, it remains a valuable concept for understanding the full scope of money and credit in an economy. It helps economists and investors see beyond the most liquid forms of money and get a sense of the total financial resources available for spending, investment, and lending. By monitoring M3, one can gain deeper insights into potential inflationary pressures, the health of the banking system, and the overall direction of the economy.