AS & A-Level Economics — Money, Banking and Macroeconomic Trade-Offs

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Original Deckloop economics study material on money, banking and macroeconomic trade-offs, with 120 practice cards and 24 concept explainers. Includes worked applications and analytical reasoning.

Economics EN A-Level

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Measuring Money: Narrow vs. Broad

Economists measure the money supply to understand the amount of purchasing power available in an economy, which influences inflation, interest rates, and economic growth. Money supply measures are categorised by liquidity. Narrow money (e.g.,

M_{0}

M_{1}

) includes the most liquid assets: physical currency in circulation and highly accessible deposits like current accounts (sight deposits). These are readily available for immediate transactions. Broad money (e.g.,

M_{2}

M_{3}

M_{4}

) encompasses narrow money plus less liquid assets, such as savings accounts, time deposits, and money market funds. These assets require a short period to convert into cash or may incur penalties for early withdrawal, making them less immediate for transactions but still representing potential purchasing power. Different measures provide varying insights into the economy's monetary conditions.

Key points

Money supply measures indicate the total amount of money in an economy.
Narrow money includes the most liquid assets: currency and sight deposits.
Broad money includes narrow money plus less liquid assets like savings and time deposits.
Liquidity refers to the ease and speed with which an asset can be converted into cash without loss of value.
Central banks monitor various money supply measures to inform monetary policy decisions.

Worked example

Question

The central bank of 'Veridia' reports the following monetary aggregates for the last quarter: Currency in

\text{circulation} = 300\,\text{billion monetary units}

;

\text{Overnight}\,\text{deposits} = 850\,\text{billion monetary units}

; Deposits with agreed maturity up to two

\text{years} = 500\,\text{billion monetary units}

; Deposits redeemable at notice up to three

\text{months} = 200\,\text{billion monetary units}

; Repurchase agreements =

100\,\text{billion monetary units}

. Calculate Veridia'

\mathrm{s} M_{1}

and

M_{3}\,\text{money}\,\text{supply}

, assuming

M_{1} = \text{Currency}

\text{circulation} + \text{Overnight}\,\text{deposits}

, and

M_{3} = M_{1} + \text{Deposits}

with agreed maturity up to two years + Repurchase agreements.

Solution

1. Identify the components for

M_{1}

: Currency in circulation and Overnight deposits.
2. Sum these components to calculate

M_{1}

.
3. Identify the components for

M_{3}

M_{1}

, Deposits with agreed maturity up to two years, and Repurchase agreements.
4. Sum these components to calculate

M_{3}

.

To calculate Veridia'

\mathrm{s} M_{1}

and

M_{3}\,\text{money}\,\text{supply}

M_{1} = \text{Currency}

\text{circulation} + \text{Overnight}\,\text{deposits}

M_{1} = 300\,\text{billion monetary units} + 850\,\text{billion monetary units}

M_{1} = 1,150\,\text{billion monetary units}

M_{3} = M_{1} + \text{Deposits}

with agreed maturity up to two years + Repurchase agreements

M_{3} = 1,150\,\text{billion monetary units} + 500\,\text{billion monetary units} + 100\,\text{billion monetary units}

M_{3} = 1,750\,\text{billion monetary units}

Therefore, Veridia'

\mathrm{s} M_{1}

1,150\,\text{billion monetary units}

, and its

M_{3}

1,750\,\text{billion monetary units}

Common pitfalls

Misconception: All money supply measures include the same assets. Correction: Money supply measures are distinguished by the liquidity of the assets they include, with narrow measures focusing on the most liquid and broad measures including less liquid assets.
Misconception: The terms 'narrow' and 'broad' money refer to the physical size or quantity of currency. Correction: These terms refer to the scope of assets included in the measure, specifically their liquidity and accessibility for spending, not their physical attributes.

Prerequisites

Deck 15 — Functions and Characteristics of Money: To categorize different forms of money into narrow and broad measures, one must first understand the general concept of money and its functions.
Basic arithmetic: Basic arithmetic (addition) is needed to sum components when calculating money supply measures like $M_{1}$ and $M_{3}$ in the worked example and card 2.