STATEMENT OF THE PROBLEM

M3 Money Supply has climbed by 40% in 2014 compared to the 5% steady

increases over the past five years.

QUESTIONS
1.
2.
3.
4.

II

What is M3 Money Supply?

What are other classification of the money supply and their functions?
What are the causes and implications of the increase in M3 Money Supply?
Is there a need to revert the increase? How?

DATA GATHERED

1. What is M3 Money Supply?

M3 Money Supply is a measure of money supply that includes M2 as well as
large time deposits, institutional money market funds, short-term repurchase
agreements and other larger liquid assets. The M3 measurement includes assets
that are less liquid than other components of the money supply, and are more
closely related to the finances of larger financial institutions and corporations than to

those of businesses and individuals. These types of assets are referred to as near,
near money.
The M3 classification is the broadest measure of an economy's money
supply. It emphasizes money as a store-of-value more so than money as a medium
of exchange hence the inclusion of less-liquid assets in M3. It is used by

economists to estimate the entire money supply within an economy, and by

governments to direct policy and control inflation over medium and long-term time
periods.
Each M3 component is given equal weight during calculation. This means, for
example, that M2 and large time deposits are treated the same and aggregated
without any adjustments. While this does create a simplified calculation, it assumes
that each component of M3 impacts the economy the same way. This can be
considered a shortcoming of this measurement of the money supply.
2. What are the other classification of the money supply and their
functions?
The Money Supply refers to the entire stock of currency and other liquid
instruments in a country's economy as of a particular time. The money supply
includes notes, coins and balances that are kept in savings and checking
accounts. There are various types of money supply and these are labeled as
M0, M1, M2 and M3, according to the type and size of the account in which the
instrument is kept. In the UK, there is also the M4 money supply classification.
Different countries may use different classifications.
M1 is a measure of the money supply that includes all physical money,

such as coins and notes, demand deposits, checking accounts and Negotiable
Order of Withdrawal (NOW) accounts. In other words, M1 measures the most
liquid components of the money supply. It contains money and assets that can
quickly be converted to cash. M1 purely focuses on the role of money as a
medium of exchange. The advent of ATMs and debit cards have meant that

bank checking accounts can now be considered as M1 since it is easy to pull

out spendable, liquid currency from them using ATMs and debit cards. M1 is
used to quantify the amount of money in circulation. M1 does not include near
money.
M2 is a measure of money supply that includes all the elements of as well
as near money. Near money" refers to savings deposits and other money
market instruments such as fixed deposits which are less liquid. They can
easily be converted to cash but are not as suitable as mediums of exchange
mediums due to their less liquid nature. M2 is a broader money classification
than M1. A consumer or business dont pay for, or receive savings deposits
during exchange of goods and services, but could convert M2 components to
cash in a short time. M2 is important because modern economies use cash
transfers between different types of accounts. For example, a business may
transfer $10,000 from a money market account to its checking account. M1 and
M2 are inter-related because a cash transfer can occur between accounts (M2),
and this transfer can be cashed by the recipient in liquid form (M1).
M3 is a measure of money supply that includes all elements of M2 as well
as large time deposits, institutional money market funds, and other larger liquid

assets. The M3 measurement includes assets that are considerably less liquid
than other components of the money supply. They tend to lean towards assets
associated more with larger financial institutions and corporations than to the
smaller business units and individuals. Such assets are known as near, near
money. The M3 classification is therefore the broadest measure of an

economy's money supply, emphasizing the role of money more as a store of

value and investment rather than as a medium of exchange. Thus a typical
Money Supply report will encompass all aspects of M1, M2 and M3.

3. What are implications and causes of the increase of M3 Money Supply?

Expansionary Monetary Policy
The Federal Reserve adds money to the system through its open market
operations, which involve open market purchases of U.S. Treasury securities,
such as Treasury bills, notes and bonds. The Fed also injects money by doing
repurchase agreements, which are overnight or short term interest bearing
deposits of money at banks and brokerage firms, secured by U.S. Treasury
securities. This maintains liquidity in the Government capital market by helping
bank and brokerage house bond trading desks to carry inventory of bonds for
their trading activities. When there is a lot of money in the system, interest rates
go down.
Interest Rates
When interest rates decline, the prices of bonds rise, giving the

bondholders a profit. When a bondholder sells his bonds to realize the profit
created by rising bond prices, the proceeds of that sale enter the monetary
system as money in circulation or money in accounts at banks and brokerage
firms. This increases the amount of money in the system and works to further
lower interest rates.

Low interest rates also attract business and personal borrowing because
the cost of borrowing money is less expensive. Businesses borrow to finance
new plant and equipment, new hires and expanded inventory. Individuals
borrow to finance purchases of homes, cars, appliances, clothing and
vacations. Business expansion and increased consumer purchases results in
more business activity, which in turn results in more employment.
Income
When business activity increases, companies hire more employees. As
the demand for new employees grows, the supply of available workers
diminishes and companies must pay higher wages to attract the best
employees, so average income rises.
As consumers take advantage of low interest rates to buy houses, prices
of those houses rise because of the increased demand. Homeowners
experience increased income as their houses appreciate in value, and they
refinance to secure lower mortgage rates or sell the houses to take a profit.
This also adds to the average income.
The result of higher average income is more money in the system and
even greater liquidity.

Inflation
As more money comes into the system, it tends to cause inflation. Many

people think inflation comes from higher prices, but this is incorrect. Inflation
refers to an inflation of the money supply. As there are more dollars chasing a

finite supply of goods and services, the prices of those goods and services will
rise because people with plenty of money will spend what they need to as they
can acquire the goods and services they desire.
Liquidity Effect
When the Fed pursues a tight monetary policy, it takes money out of the
system by selling Treasury securities and raising the reserve requirement at
banks. This raises interest rates because the demand for credit is so high that
lenders price their loans higher to take advantage of the demand. Tight money
and high interest rates tend to slow economic activity and can bring on a
recession. During periods of tight money companies, terminate employees and
consumers cut back on their spending. House prices also decline as fewer
people are able to afford the boom time prices. So, low liquidity has the
opposite effect on the economy from high liquidity.
4. Is there a need to revert the increase in M3? How?
An increase in M3 Money supply is usually a result of an implementation
of Expansionary Monetary Policy. The need to control the money supply
depends on other prevailing issues such as inflation and purchasing power.
Contractionary Monetary policy can revert the increase in Money Supply.

1
III

ANALYSIS OF DATA
STRENGTHS (Pros)

WEAKNESSES (Cons)

Increased economic activity

Liquidity is high
Decrease on unemployment rate
Interest rates are lower
Easy credit

Inflation
Decreased Purchasing Power
Adverse effect on trade balances

OPPORTUNITIES
-

I
V

Further Economic Growth

THREATS
-

Hyperinflation
Devaluation

ALTERNATIVE COURSES OF ACTION

1. Enforce Expansionary Monetary Policies

Expansionary monetary policy seeks to expand the money supply to encourage
economic growth or combat inflation (price increases). One form of expansionary
policy is fiscal policy, which comes in the form of tax cuts, rebates and increased
government spending. Expansionary policies can also come from central banks,
which focus on increasing the money supply in the economy.

1
PROS If the country in subject have gone through recession and economically
suffering still amidst the increase in money supply, the country should enforce the
expansionary policies until such time that it has fully recovered.

CONS The increase in money supply might have already adverse effects and it
needs to be stopped.
2. Keep policies unchanged
This is equivalent to doing nothing at all.
PROS It is more likely that the country in subject have not undergone recession
as evident in the steady increase in money supply over the past five years. This
means that the increase could have been only temporary, as a result of an external
factor. It is possible that the increase is short term and will revert itself in tme.
CONS If the increase will continue for a longer time, the central bank should not
just keep the policy unchanged and should have controlled the money supply as
soon as it was proven detrimental to the economy.
3. Implementation of Contractionary Monetary Policy
Contractionary policy, unlike expansionary, expands the money supply more
slowly than usual or even shrinks it.
PROS If the increase in money supply is proven adverse in nature in the long
run, it is wiser to combat the increase of the supply now.

CONS It might e too early to implement contractionary policies.

CONCLUSION

Increase in the money supply could be a result of the implementation of

expansionary monetary policies. It could also be caused by an outside factor such
as shift of foreign investment from one country to the country in subject. The
increase is not necessarily detrimental or a problem at all.
For this problem, it is uncertain whether the increase was sudden, plan or
effectuated by the central bank of the country in subject. It is also uncertain whether
the increase will continue for a longer period or will only revert itself in a short time,
or other. Therefore, with the given data it is improbable to determine the effects and
cause of the increase. The solution thence is highly dependent on other information
other than what is given.

RECOMMENDATION
Our group recommends any of the three given alternatives. We believe that
we cannot fully determine the effects and causes of the increase and as such, it is
improbable to recommend a definitive solution. If the conditions of the country in
subject be the scenarios as enumerated on the alternative courses of action, the
central bank of the country in subject should act accordingly.
In other words: we recommend alternative number 1 if the increase was

effectuated by the central bank itself to combat recession and it intends to continue
the increase; we recommend alternative two if the increase is temporary or will
revert itself in a short period of time; and we recommend alternative three if the
increase is unwanted and/or increases risk of high inflation.

REFERENCES

Investopedia, Definitions (M3 and Money Supply), retrieved from

http://www.investopedia.com/
Econmentor, Functions of money/M1/M2/M3/Opportunity cost of money
Retrieved from http://www.econmentor.com/college-macro/macro-

topics/money/
Boundless. The Effect of Expansionary Monetary Policy, 21 Jul. 2015.

Retrieved from https://www.boundless.com/economics/

Tim McMahon, M3 Money Supply Numbers are Back- Sort Of 18 Oct 2010,
retrieved from http://inflationdata.com/articles/2010/10/18/m3-money-supply-

numbers-are-back-sort-of/
The US Federal Reserve Bank, Money supply M1, M2, M3 retrieved from

http://www.forex4you.com/en/forex/economic-indicators/money-supply/
The Money Supply retrieved from
http://wfhummel.cnchost.com/moneysupply.html