Money Measurement: Definitions, Classifications, and Control
Measurement of Money: Definitions and Classifications
The definition of money is widespread, and it is often said that money is everything. However, for economic analysis, we need a more precise understanding. Here’s a general classification of monetary assets:
Monetary Aggregates
- M1: Assets held by the public, including currency and demand deposits.
- M2: M1 plus savings deposits.
- M3: M2 plus term deposits.
- M4: Liquid assets in the hands of the public, including M3 plus promissory notes and treasury bills.
These aggregates are used to control the money supply in an existing economy. The essential objective is to control the amount of money, and both the conduct of the study and economic markers vary. The added elements differ from each other, and their behavior changes over time. Estimations are not exact, and there is an element of uncertainty.
The Godhart Problem
Additional measures, known as the Godhart problem, affirm that no single aggregate should be taken as a guide or objective of monetary policy. Instead, the aggregate that has a different behavior should be chosen by the authorities. Currently, the amount of money is controlled through M4. Monetary authorities set a target for liquid assets expansion within a band whose central value is consistent with the expected target of GDP increase plus the expected price increase.
If the increase is much above the band, the monetary authorities conduct a series of measures to place the values within the target. The monetary base is accepted at any time by the central bank. Monetary policy aims to control the amount of money. The main items affecting the money supply are:
Central Bank Actions
- Securities Purchases and Sales: The central bank may purchase or sell securities, amending the money supply. Purchasing securities expands the money supply through commercial bank reserves.
- Discount Bills: If the central bank provides trade well discount bills, paying money, the result is the same as in the previous case.
- Gold and Foreign Exchange: While gold has lost importance, holding foreign exchange reserves increases the money supply if these reserves increase.
Term Foreign Exchange Market
This is a market where you can buy and sell currencies at a specified future price. In these markets, contracts are made at a specified forward price (FT) for the future delivery of a currency at a specified time (T), usually within one year. Each financial institution performs the operation. There is no delivery of anything, only an agreement between the bank and the client to cover the evolution of the exchange rate. The current exchange rate does not match the exchange rate fixed in the forward market.
The difference between the forward and current exchange rates, expressed as a percentage, is:
FR = (FT – S) / S
Where S is the current exchange rate.
- If FR is greater than zero, it indicates a term premium.
- If FR is less than zero, it indicates a term discount.
- If FR is positive, the market expects the euro to depreciate, and the foreign currency to appreciate.
- If FR is negative, the euro has appreciated, and the foreign currency depreciates.