Inflation greatly impacts the fiscal and monetary policies implemented in an economy. These policies’ role is to either withdraw money from the economy or inject more money into it. Fundamentally, the inflation rate tends to fluctuate depending on the money supply. When the money supply is high, so is the inflation rate, and when it’s low, the inflation rate decreases. For this reason, monitoring money supply data is crucial and can be used as a leading indicator of inflation.
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What is Money Supply?
Money Supply is the total amount of monetary assets circulating in an economy at a specific time. It is considered an important tool in controlling inflation.
Money supply includes cash circulating in the economy, bank deposits, and other liquid assets that can be quickly converted into cash. Note that money supply is measured over a specific period and excludes any physical assets that must be sold to be converted into cash, credit limits, and credit cards.
There are four measures of money supply: M0, M1, M2, and M3.
Distinguishing M0, M1, M2, and M3 Money Supply
When you explore what money supply is, you will encounter concepts such as M0, M1, M2, and M3 money supply. Their differences are as follows:
- M0 Money Supply: The total amount of cash circulating in the economy.
- M1 Money Supply: The total amount of cash circulating + demand deposits at commercial banks. (Cash held by central banks is excluded from M1).
- M2 Money Supply: The total amount of cash circulating + demand deposits + time deposits at commercial banks.
- M3 Money Supply: Includes M2 Money Supply + larger term deposits, less liquid, typically financial assets of financial institutions and large corporations.
Using Money Supply in Analysis
As mentioned earlier, both fiscal and monetary policies are influenced by the money supply. For businesses, investors, consumers, etc., analyzing money supply not only helps predict interest rates but also to determine the business cycle, thereby inferring expected changes in prices and inflation.
Money Supply and GDP: Money supply in the economy can be used to analyze and determine a country’s business cycles.
- When the money supply increases, it stimulates consumer demand. Businesses can easily borrow money, expand production and hire more labor to meet demand. This leads to economic growth and a strong increase in GDP. You will see that when the economy is going through recovery and expansion to its peak (strong GDP growth), the economy’s money supply will steadily increase. During the recovery, total demand increases, unemployment rates decrease, and people’s welfare improves.
- Conversely, money supply starts to decrease when the economy is going through a recession. These phases are characterized by a decrease in GDP indicating an economy in contraction, accompanied by higher unemployment rates and decreased total demand in the economy.
Furthermore, an increase in the economy’s money supply leads to a decrease in interest rates. Businesses can then invest more in production and business operations, and the demand for labor increases. Moreover, an increased money supply stimulates consumer demand. With both total supply and demand increasing, the economy expands, and GDP growth is inevitable.
Money Supply and Inflation: The most notable impact of money supply is inflation. Inflation is the increase in prices of goods and services over time.
- As the money supply continues to increase, it indicates that households have more money to spend, increasing total demand. Since supply does not change at the same rate as demand, the resulting scenario is an increase in the prices of goods and services. In most countries, central banks have an inflation target rate. Therefore, when inflation rises, central banks will use contractionary monetary policies, such as increasing interest rates. Contractionary policies are designed to increase the cost of money and discourage consumption. Therefore, in the forex market, an increase in money supply can be seen as a signal that interest rates will rise in the future, which will make the domestic currency appreciate against other currencies.
- On the other hand, a decrease in money supply signals an economic recession, job loss, and a contracting economy. For governments, preventing economic recession is of utmost importance. Therefore, a continuous decrease in money supply will trigger the implementation of expansionary fiscal policies. Fiscal policies may be accompanied by the central bank’s expansionary monetary policies. These policies aim to stimulate economic growth and are negative for the currency. Hence, a decrease in money supply implies that interest rate cuts may occur in the future, which will make the domestic currency depreciate against other currencies.
Where to Find Money Supply Data?
In the United States, the Federal Reserve publishes monthly money supply data at: Money Stock Measures – H.6 Release. You can find detailed data on US money supply at:
Or, you can access in-depth evaluations of the total money supply of the United States at St. Louis FRED, with historical data:
- M1 Money Supply: https://fred.stlouisfed.org/series/M1
- M2 Money Supply: https://fred.stlouisfed.org/series/M2
- M3 Money Supply: https://fred.stlouisfed.org/series/MABMM301USM189S
– To research money supply data of various countries, visit: Tradingeconomics.com
- M1: https://tradingeconomics.com/country-list/money-supply-m1
- M2: https://tradingeconomics.com/country-list/money-supply-m2
- M3: https://tradingeconomics.com/country-list/money-supply-m3
– In the EU, money supply data can be accessed from the European Central Bank: HERE
And of course, do not overlook some websites for economic calendar research, such as:
- https://www.forexfactory.com/
- https://www.investing.com/economic-calendar/
How Does Money Supply Affect the Forex Market?
Since money supply influences future interest rate decisions, any information about money supply impacts the currency pair of that country traded in the Forex market.
However, as money supply affects interest rates indirectly, i.e., it increases inflation rates and then (MAY) influence interest rates. Therefore, the impact of money supply on Forex is not too significant.
For instance, information about Supply Money on Investing.com.
The importance level of this data is only at 1 star, indicating low importance. Therefore, money supply data is often considered to have a mild impact on Forex price action.
However, when examining money supply data, it’s important to compare it to expectations. If the data is worse than clearly anticipated in the market, or better than forecast, it can cause fluctuations. For example:
In August 2020, M3 money supply in Europe increased by 9.5% compared to a 10.1% increase in July. The increase in August was lower than analysts’ expectations of 10.2%
Now, let’s see how the release of this data impacted the Forex price chart.
– EUR/USD: Before the release of M3 money supply data on September 25, 2020 (the area between the two red dashed lines).
Before the release of M3 money supply, the EUR/USD pair was trading in a slight upward trend. The candles were forming right above the 20-period MA.
Below is after the release of M3 money supply data on September 25, 2020.
This pair formed a downward candle 5 minutes after the data was released. Then, the pair had to accept a strong downward trend below the MA 20, marked by continuously deep downward candles that followed.
IN SUMMARY: Although money supply data is not considered very important, in many cases, if money supply data differs from forecasts, it can cause strong fluctuations in the Forex market. Therefore, monitoring the economic calendar – especially money supply (Supply Money) data, and understanding the concept of money supply will help you gain knowledge and respond timely to market fluctuations.
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