Money Supply and Definitions

We all know the importance of money as a medium of exchange and storage of value. Changes in the economy caused by changes in the quantity/supply of money have been the subject of discussion among economists for many years. In summary, the classical school believing in the quantity theory of money, which is one of the two primary schools of thought, argued that the increase in cash (more than necessary) would cause inflation. In contrast, the Keynesian school has argued that the rise in the amount of money will bring vitality to the economy through falling interest rates and positively affect growth.

However, to measure these effects, the money supply must first be defined so that statistical measurements regarding the money supply can be made quickly.

Before the money supply, we will define a monetary base consisting of paper and metal money in circulation in the market, banks' vaults, and the Central Bank. Another name for the economic base is ‘emission volume.’ Economists use the term M0 for the short notation of this definition.

Money creation in an economy is not just money in circulation (the volume of emissions) that the Central Bank issues by printing. We know that all banks lend the money deposited in their accounts as credits after putting aside a part of those funds in a proportion determined by the central banks. This loan generally ends up in the banking system as a deposit after the borrower spends it. This systematic process of money creation is what constitutes the ‘bank money.’ The amount made in this way and the sum of demand deposits form the most critical part of the money supply. The Central Bank uses the proportion that the banks are required to hold as a policy tool; when a central bank decreases the reserve requirement ratio, the part of the deposited money that can be lent increases and would increase the money supply.

Thus, we have made our first definition of money supply, which economists call M1;

M1 = M0 - cash in banks + demand bank deposits (excluding deposits held by banks at the Central Bank)

We removed the cash in banks and accounts held in the Central Bank because it could not participate in the money supply. Some definitions divide demand deposits into two groups in the M1 description as retail and wholesale demand deposits. Retail accounts consist of accounts in which the interest rate to be given is announced through various channels. Whereas wholesale accounts are made up of accounts from which the account holders negotiate with banks and collect interest on them (This distinction is ignored since interest is not paid for demand deposits in our country).

If we add time deposits to the M1 defined money supply, a broader money supply; we have reached the definition of M2.

Finally, the money supply in the broadest sense, which was changed by the Central Bank's final regulations, is defined as M3. This measure consists of repo transactions, money market funds, and the addition of issued securities to M2.

M3: M2 + Repo + Money Market Funds + Securities Issued

The securities issued include bonds and bills issued by banks in Turkish Lira with original maturities of up to two years. Those held in the portfolio of domestic banks and those owned by non-residents are deducted from these issues.

Prof. Dr. Fuat Beyazit


D.Begg, S. Fischer, R. Dornbusch, Economics, 5th Edition, McGraw-Hill, 1997.

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