M3 Money Supply: Definition, Liquidity, Disuse, and M Classifications

Exploring the M3 measure of the money supply, including its definition, liquidity components, reasons for its disuse, and comparison with other M classifications.

M3 is a measure of the money supply that encompasses M2 along with large time deposits, institutional money market funds, and short-term repurchase agreements. It provides a broad view of the total money available within an economy.

Components of M3

M2 Money Supply

Before delving into M3, it is essential to understand M2, which includes:

• M1 Money Supply: Consists of physical currency, demand deposits, travelers’ checks, and other checkable deposits.
• Savings Deposits: Accounts that are accessible but not as liquid as demand deposits.
• Small Time Deposits: Time deposits less than $100,000 not immediately accessible without a penalty.
• Retail Money Market Funds: Money market mutual funds available to individual investors.

Additional Components in M3

• Large Time Deposits: Time deposits over $100,000 which include certificates of deposit (CDs) that have set periods.
• Institutional Money Market Funds: Managed pools of funds to provide liquidity for institutional investors.
• Short-Term Repurchase Agreements (Repos): Agreements involving the sale and future repurchase of government securities, typically within 24 hours.

Liquidity of M3

M3 comprises various components differing in liquidity. It spans from the highly liquid physical currency and demand deposits to the less liquid large time deposits and short-term repos. Understanding liquidity within the context of M3 is crucial as it reflects the overall capability of an economy to fulfill financial obligations and invest.

Disuse of M3

Historical Context

Historically, M3 was a key metric for central banks, especially the Federal Reserve, to gauge the overall money supply. However, it was discontinued in 2006 as it was deemed less informative and redundant compared to M2 for policy reasons.

Modern Relevance

In contemporary economics, the focus often remains on M1 and M2. The complexity and components of M3, while providing an expansive view, were considered excessive for routine monetary policy and economic analysis.

Comparison with Other M Classifications

M0 and M1

• M0 (Monetary Base): Includes all physical money in circulation and reserves held by banks.
• M1: Focuses on the most liquid forms of money, such as physical currency and overnight deposits.

M2

• M2: Expands on M1 to include savings deposits, small time deposits, and retail money market funds, reflecting a broader spectrum of money readily available for transactions.

FAQs

Why was M3 discontinued by the Federal Reserve?

The Federal Reserve discontinued M3 in 2006 since it was considered to add little additional value compared to M2 for policy purposes and was costlier to maintain.

How do institutional money market funds impact the liquidity of M3?

Institutional money market funds are included in M3 as they represent liquid assets managed for large-scale investors, which can significantly impact the liquidity availability in financial markets.

What role do large time deposits play in M3?

Large time deposits, such as CDs over $100,000, add a longer-term savings dimension to M3, reflecting more stable but less liquid assets compared to the components of M1 and M2.

References

• “Federal Reserve Statistical Release,” Federal Reserve Board.
• “Monetary Aggregates,” Board of Governors of the Federal Reserve System.
• Mishkin, Frederic S. “The Economics of Money, Banking, and Financial Markets.”

Summary

M3 is a comprehensive measure of money supply that includes M2 in addition to large time deposits, institutional money market funds, and short-term repurchase agreements. While it offers an extensive perspective of monetary availability, the Federal Reserve has discontinued it due to redundancy and cost concerns. Understanding M3 remains crucial for a complete view of economic liquidity and the various layers of money accessible within an economy.