Economic Indicators: Money Supply

The Federal Reserve publishes weekly and monthly data on two money supply measures known as M1 and M2. The Fed reports money supply data at 4:30 p.m. every Thursday.

According to the New York Fed’s website:

•          For decades, the Federal Reserve has published data on the money supply, and for many years the Fed set targets for money supply growth.
•          In the past two decades, a number of developments have broken down the relationship between money supply growth and the performance of the U.S. economy.
•          In July 2000, the Federal Reserve announced that it was no longer setting target ranges for money supply growth.
•          In March 2006, the Board of Governors ceased publishing the M3 monetary aggregate.

M1 is defined as the sum of currency held by consumers as well as deposits held at depository institutions like banks and savings and loans. M2 is defined as M1 plus savings deposits plus low denomination time deposits plus money held in retail money market accounts.

In recent periods the relationship between the money supply and various other economic indicators such as GDP growth and inflation have been less consistent than in the past.

Why the Money Supply is important

The Federal Reserve has a measure of control over the money supply aggregates, which differentiates this indicator from most others. Through open market operations such as buying and selling Treasuries and setting the reserve requirements, the Fed does things to alter the money supply through its daily course of business.

The instability of the relationship between the money supply and other economic indicators has diminished the money supply as a guide to the Fed’s course in setting monetary policy.

The FMOC still reviews money supply data, but it is now one of a number of indicators that are used by the committee in making their monetary policy decisions.

No single release from the Fed regarding the money supply is going to shock the market; the weekly release schedule alone takes a lot of the surprise factor out, so this report will rarely move the markets in the short term.

The M2 figure is looked at more than the rest —cash equivalents in this designation are deemed to be collectively liquid enough to be spent without any real delays or penalty costs. While growth in the money supply does not directly indicate future spending growth as it once did, it does indicate that inflation could be around the corner. This is where knowing both money supply growth and GDP growth becomes very handy—if money supply growth is rapidly outpacing economic growth, there will soon be more money chasing after the same amount of goods. This supports the famous quote from economist Milton Friedman: "Inflation is always and everywhere a monetary phenomenon."

Strengths of the Money Supply:

• A timely and consistent indicator, released weekly and with a long operating history
• It is often misunderstood by investors, creating opportunities for those who know how to use it
• There is a lot of existing research on the relationship between money supply and GDP growth as well as inflation

Weaknesses of the Money Supply:

• Rarely a mover of the markets in the short term
• Limited breakdowns available in the weekly release; the quarterly Flow of Funds report provides a broader view
• Lack of economic consensus on how to best compare money supply levels to inflationary outlook and future spending patterns