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How do we measure the money supply?

What do you think money is? The obvious answer is that it is notes and coins which can be used to exchange for goods and services. After all, money is a medium of exchange. The money supply is important because it is said to give some indication of the extent to which spending will occur. If my employers give me a generous 50% pay increase, I will have more money in my pocket and I am likely to want to spend at least some of it on items that previously I might not have been able to afford.

In simple terms, therefore, we might be able to relate the money supply to the level of spending in the economy.

These days, people tend to use notes and coins less than they did 30 years ago, for example. 30 years ago, the number of people paying for their weekly shopping or their petrol by credit card was very small compared to the number who now use this method of payment. A credit card is not strictly money, however, although a charge card where the funds are deducted directly from a bank account is a form of money. Herein lays one of the problems in measuring the money - what exactly is money?

A cheque and credit cards - both can be used to purchase goods and services. Are they both therefore forms of money? Copyright: Arjun Kartha and Lotus Head.

Notes and coins in circulation must be supplemented by money in bank accounts if we are to get a more accurate measure of the money supply. I have money in my bank account, which represents potential spending power but which I do not carry around with me.

I also have various savings accounts which represent potential spending, but which I might not be able to access immediately. It might be that some of these accounts require some time period or notification before I can access my cash. What about shares in a plc? I could sell those tomorrow and get the cash to be able to go and buy something.

You get the picture! Actually, getting some clear definition of what we mean by the money supply is not that easy and has frustrated various chancellors who have tried to target a specific measure of the money supply.

The Bank of England currently has two main measures of the money supply that they publish: narrow money (notes and coin and reserve balances), and broad money (M4) and credit (M4 lending).

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