Money supply is the currency and other liquid instruments in a country's economy. Money supply includes cash and other types of deposits that can be used as easily as cash. The U.S. Federal Reserve System publishes data on the money supply as it relates to real economic activity and prices. The Gross Domestic Product (GDP) is a measurement of the total value of all the finished goods and services produced within a country's borders within a specified period of time. GDP is used as a comprehensive indicator of a country’s overall economic health.
Key Takeaways
- Money supply refers to all the currency and other liquid instruments in a country's economy.
- Gross domestic product (GDP) measures the total value of all the finished goods and services produced within a country's borders within a specified period.
- The nominal GDP tends to rise with the money supply.
- Real GDP is the nominal GDP adjusted for inflation.
Measuring the Money Supply and GDP
Money supply data published by the Federal Reserve are named M1 and M2. M1 includes money commonly used for payment, such as currency. M2 adds in savings deposits and retail money market accounts. Most economists use the Federal Reserve M1 and M2 measures. Money supply data from the Federal Reserve is published in reports available at 4:30 p.m. every Thursday. As of August 2023, the Fed's Money Stock Measures were approximately $21 billion.
GDP is a measurement of the total value of all the finished goods and services produced within a country's borders within a specified period and is considered an indicator of overall economic health. In the U.S., the government releases data about the country's GDP on an annual and quarterly basis. Nominal GDP refers to the GDP calculated at current market prices. Real GDP is an inflation-adjusted measure. As of August 2023, Real GDP in the United States measured $27 billion.
Some economists like Milton Friedman have argued that the money supply provides important information about the short-term course of the economy and determines the level of prices and inflation in the long run.
Increasing the Money Supply
The relationship between money supply and the GDP depends on the short-term or long-term view of the economy. The nominal GDP tends to rise with the money supply. Real GDP, also referred to as "constant price," "inflation-corrected," or "constant-dollarGDP," is an inflation-adjusted measurement. Real GDP does not have a clear relationship with the money supply. Real GDP tends to be influenced by the productivity of economic agents and businesses.
Theories of macroeconomics cite that an increase in money should lower interest rates in the economy with more money available for borrowing. This increase in supply tends to lower the cost of borrowing money. When it is easier to borrow money, rates of consumption andlending go up. In the short run, higher rates of consumption, lending, and borrowing can be correlated with an increase in the total output of an economy andspending and, presumably, a country's GDP.
However, the long-term impact of an increase in the money supply is difficult to predict. Prices of assets, such as housing and stocks, artificially rise following an increase in the money supply or anything that results in a high level of liquidity entering the economy. This misallocation of capital can lead to waste and speculative investments, resulting in the rapid escalation of asset prices followed by a contraction or recession, a significant decline in economic activity.
Rising GDP
While a country's GDP is not a perfect representation of economic productivity and health, a higher level of GDP is more desirable. A country's GDP provides information about the size of its economy, and the GDP growth rate is one of the best indicators of economic growth. GDP does not denote a country's standard of living, butGDP per capitameasures trends in the standards of living and whether the average citizen in a country is better or worse off.
When the GDP growth rate shows rising economic productivity, the value of money in circulation increases. This is because each unit of currency can subsequently be exchanged for more valuable goods and services. Economic growth tends to have a natural deflationary effect, even if the supply of money does not shrink.
Monetary Policy
Any actions by central banks to increase or decrease the money supply are referred to as monetary policy. The U.S. Federal Reserve has three general macroeconomic goals: price stability, sustainable economic growth, and high employment. There are many reasons why the money supply in a country may be growing, including the following:
- The central banks of countries may print more money.
- Banks may choose to lower their liquidity ratio and lend a larger proportion of their funds to consumers and businesses.
- There can also be an influx of funds from abroad if a central bank buys up its currency from foreign exchanges to build up its foreign reserves.
- The government may also increase the money supply through its activities, primarily by buying government securities.
What Are Open Market Operations?
The U.S. Federal Reserveconductsopen market operationsby buying or selling Treasury bonds and other securities to control the money supply. With these transactions, the Fed can expand or contract the amount of money in the banking system and drive short-term interest rates lower or higher depending on the objectives of itsmonetary policy.
How Is Nominal GDP Calculated?
Nominal gross domestic product (GDP) is GDP in current prices, without adjustment for inflation.
Who Controls the Money Supply in the United States?
The money supply is managed by the Federal Reserve. The Federal Reserve establishes monetary and fiscal policies to influence the economy, create jobs, or combat inflation.
The Bottom Line
Money supply refers to all currency and other liquid instruments in a country's economy. Gross domestic product (GDP) tallies the total value of all the finished goods and services produced within a country's borders within a specified period. Some economists argue that the money supply provides information about the short-term course of the economy and determines the level of prices and inflation in the long run, affecting GDP.
