Five simple truths embody most of what we know about inflation, according to Milton Friedman, Ph.D, American economist and a Nobel Prize in Economic recipient:
- Inflation is a monetary phenomenon arising from a more rapid increase in the quantity of money than in output (though, of course, the reasons for the increase in money may be various).
- In today’s world government determines – or can determine – the quantity of money.
- There is only one cure for inflation: a slower rate of increase in the quantity of money.
- It takes time – measured in years, not months – for inflation to develop; it takes time for inflation to be cured.
- Unpleasant side effects of the cure are unavoidable.
The money supply
The money supply is the stock of money in the economy. It is determined by the roles and uses to which certain physical and financial assets are put.
Money performs a number of roles in our economy. Money functions
- as a medium of exchange;
- as a unit of account;
- as a store of value; and
- as a means of making payments inter-temporarily, i.e., over time. Its most obvious role, the one everyone is familiar with, is as a medium of exchange
The Money Aggregates (M1, M2 and M3) are money supply measures are that are meant to reflect differing roles of money;
Money Stock M1 — M1 is made up of notes and coin and several other financial instruments that the general public may not consider to be money. However, the Federal Reserve includes them because they are used as a medium of exchange and thus, on that account, perform a monetary function. Consequently, M1 is composed of currency in the hands of the public, checking accounts at commercial banks, deposit accounts against which checks can be written, and traveler’s checks issued by institutions that are not banks.
Money Stock M2 — M2 is a broader measure of the money supply than M1. It counts as money not only those financial instruments that generally act as a medium of exchange but also act as a store of value, another important function of money. Therefore, M2 includes M1 plus three other types of financial assets. These are (i) savings deposits, including money market deposit accounts; (ii) fixed deposits less than $100,000; and (iii) and retail money market mutual funds.
Money Stock M3 — M3 consisted of time deposits $100,000 and over, repurchase agreements (RPs) larger than $100,000 and longer than one day (called term RPs), and institutional money market mutual fund accounts.
Sometimes, M0 is used to denote central bank money, which consists of coin and currency in circulation, cash in bank vaults, and balances held in reserve accounts at the central bank by commercial banks and other depository institutions. In the U.S., M0 is called the “monetary base (MB).”
MI measures money used as medium of exchange, while M2 measures money used as store of value.
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