Broad Money
Broad money is a monetary aggregate that includes a wide range of financial assets used for transactions and held as stores of value. It typically comprises currency in circulation, demand deposits, and other liquid assets such as savings and time deposits, money market instruments, and, in some definitions, longer-term deposits and repurchase agreements. Broad money is distinguished from narrow money, which includes only the most liquid assets. The definition varies across countries and over time, reflecting differences in financial systems and in the purposes for which the measure is used.
Measures and definitions
Monetary aggregates are usually arranged in a hierarchy. The narrowest measures include currency in circulation and the reserves held by banks. Broader measures add demand deposits and other checkable deposits, then savings deposits, time deposits, and money market instruments. The exact composition differs across countries. The terminology of M0, M1, M2, M3, and M4 is common, though the definitions attached to each vary, and analysts must be careful to compare like with like.
International standards, including the monetary and financial statistics framework, provide guidance on the definition and compilation of monetary aggregates, aiming to improve comparability. Central banks publish the aggregates regularly and use them, alongside other indicators, to assess monetary conditions.
Role in monetary analysis
Broad money is used to assess the relationship between money and nominal income, and to monitor inflationary and deflationary pressures. Historically, some central banks targeted the growth of a monetary aggregate as an intermediate objective, on the assumption that the demand for money was stable and that controlling money growth would control inflation. This approach, known as monetary targeting, was adopted by several countries but was largely abandoned after the 1980s.
The demand for money proved less stable than assumed, as financial innovation created new substitutes for traditional money and blurred the boundaries between aggregates. The velocity of circulation, the ratio of nominal income to money, became unpredictable, undermining the usefulness of monetary targets. Central banks shifted toward interest-rate-based frameworks and inflation targeting, using monetary aggregates as information variables rather than targets.
Determinants of broad money growth
Broad money expands through the creation of bank deposits, which arises when banks extend credit or purchase assets. The central bank influences this process through the monetary base and reserve requirements, and through its policy rate. The money multiplier, the ratio of broad money to the monetary base, captures the relationship, though it is not stable and depends on banks' willingness to lend and on the public's preference for holding different types of assets.
Changes in broad money reflect a combination of factors, including the growth of credit, capital flows, fiscal operations, and shifts in portfolio preferences. Distinguishing these factors is important for interpreting the significance of money growth for inflation and activity, since a rise in money driven by credit expansion may signal different pressures than a rise driven by a flight to safety.
Broad money and financial conditions
In recent decades, central banks have come to rely less on monetary aggregates and more on a broad range of indicators of financial conditions, including credit growth, asset prices, and yield spreads. Broad money remains useful as one input, particularly in economies where the financial system is bank-based and where money and credit are closely linked to economic activity.
During the global financial crisis and the subsequent period of unconventional monetary policy, central bank balance sheets expanded dramatically, and broad money grew rapidly in some economies, raising questions about the implications for inflation and asset prices. The experience showed that the relationship between money, credit, and inflation is complex and depends on the state of the economy and on the behaviour of banks and households. Monitoring broad money alongside other indicators remains part of the analytical toolkit.
Monetary aggregates and financial stability
Broad money growth can signal the build-up of financial vulnerabilities. Rapid credit expansion, often reflected in strong growth of broad money, has preceded many financial crises, as it fuels asset price increases and leverage. Monitoring money and credit growth, alongside asset prices and lending standards, is therefore part of the macroprudential toolkit.
The relationship between money growth and financial stability is not automatic. Money growth driven by strong economic fundamentals may be benign, while growth driven by speculative lending may be dangerous. Distinguishing between these cases requires analysis of the composition of credit, the sectors to which it flows, and the lending standards applied. Central banks and macroprudential authorities therefore examine a range of indicators, including money and credit aggregates, in assessing risks to stability.
International comparisons
Definitions of broad money differ across countries, complicating comparisons. Some countries include repos and money market fund shares, while others exclude them. Financial structure also matters, since bank-based systems generate more money and credit relative to GDP than market-based systems. These differences mean that cross-country comparisons of money growth must be interpreted with care.
International standards aim to harmonise definitions, but differences persist. Analysts compare the growth of money and credit relative to nominal GDP, the ratio of broad money to GDP, and the composition of the aggregates, to assess monetary conditions and financial development. Understanding these measures and their limitations is essential for comparative analysis and for policy.
Money in the digital age
The digitalisation of payments and the emergence of new forms of money, including central bank digital currencies and stablecoins, are changing the nature of monetary aggregates. Digital payments reduce the demand for physical currency, and new instruments blur the boundary between money and other assets. These developments complicate the measurement and interpretation of monetary aggregates and raise questions about the future of monetary analysis.
Central banks are studying the implications of digital currencies for monetary policy, financial stability, and the payment system. The design choices, including whether digital currencies pay interest and whether they are available to the public, have significant implications for the demand for money, for bank funding, and for the transmission of policy. Understanding these changes is essential for adapting monetary frameworks to a changing financial landscape.