Fed Facts: What Is The Money Supply?

Much ado has been made over the past 100 years of The Federal Reserve System and its ability to influence (or control, depending on who you ask) the U.S. economy. However, even a business school education from a major university doesn’t guarantee you’ll be able to follow along with all the dinner table talk of “the Fed” and its manipulation of economic factors like the money supply, as many of us don't understand what exactly this phrase means.

The money supply is simply a phrase used to describe the monetary base, called M1 and M2.

• M1 is the sum of cash in circulation across the entire country, including funds held as deposits by banks.
• M2 is the sum of M1 plus money held in savings accounts, small-balance time deposits (e.g. certificate of deposit accounts) and money market accounts.

The Fed is often said to manipulate the money supply through changing the interest rate (also referred to as the discount rate).

• When the rate is low, the Fed is encouraging banks to borrow money from the Fed to invest, make loans, et cetera. This should increase the money supply.
• When the rate is raised, this should discourage banks from borrowing as much, causing them in turn to make fewer loans and so forth, thereby reducing the money supply.

Other money-managing techniques available to the Fed are quantitative easing and the use of “helicopter money.”

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