M3 Money Supply

M3 Money Supply is an indirectly derived measure of the supply of money which includes currency with the public; current and savings deposits with the banking system; bank-issued certificates of deposit; Term deposits of residents; call/term borrowings from 'non-depository' corporations by the banking system; and 'Other' deposits with the central bank.

The M3 money supply is a seasonally-adjusted indicator. M3 captures the entire banking sector's balance sheet. It is also called broad money and is derived by adding another money aggregate M2 with bank deposits for up to two years, repurchase agreements of up to three months, and money market fund shares/units.

• The M3 money supply is one of the monetary aggregate, known as 'broad money.' It reflects the economy's money supply as it is the most comprehensive in the assets constitution.
• Economists study it as a parameter to determine an economy's total money supply. Based on M3 central bank used to drive monetary policy to regulate rising prices, consumption, expansion, and liquidity over the medium to long term.
• While determining M3, each component gets equal weightage. Therefore, it is considered a major flaw as it may misrepresent the information.
• It is an indirectly derived and seasonally adjusted indicator.

The M3 money supply is a broad money aggregate that reflects the economy's money supply. There are three metrics of the money supply, known as "money aggregates," which are M1, M2, and M3 money supply.

M3 is the sum of M2 (M2 is the sum of M1 (sum of currency in circulation and overnight deposits), deposits with an agreed maturity of up to two years and deposits redeemable at notice of up to three months), repurchase agreements, money market fund shares/units and debt securities with a maturity of up to two years.

As storage of value rather than an exchange medium, M3 includes less liquid assets, which are less available for immediate use if needed.

Economists historically employed M3 to determine the total money supply in an economy. In addition, central banks used M3 to arrive at monetary policy to regulate rising prices, consumption, expansion, and liquidity over the medium to long term.

The money supply in the economy depends on many factors. First, open market operations allow central banks to have some control over the money supply. Second, money comes into the economy using government securities like bonds and treasury bills, affecting supply. Third, increasing liquidity in the banking system due to the conversion of commercial banks' illiquid securities into deposits at the central bank. Due to the increasing demand, the price of such assets rises, and interest rates fall. Commercial banks may now lend these sums because of the multiplier effect of fractional-reserve banking, which causes the value of bank deposits and loans to rise many times over the initial investment.

As a result, when the central bank toughens the money supply, it takes liquid cash out of the banking system by selling assets. So as the supply of such assets increases and interest rates rise, the price of such securities decreases. This has a multiplication impact, as well.

In the United States, each component gets equal weight when calculating M3. This does simplify the computation, but it presupposes that each component of M3 has the same effect on the economy, which is not the case in the real world.

This equivalent weight is faulty in the M3 measure of the money supply, which is why it is no longer a valid measure. 

In making monetary policy choices, the Fed does not take M3 into account. Since 2006, the Federal Reserve has stopped keeping track of M3. Also, exclusive less liquid components of M3 did not appear to transmit additional economic information already captured by the more liquid components of M2.

However, as per some experts, M3 is the best way to describe Fed's money-creation rate. Hence it should be considered. This is because they believe that creating new money out of thin air by a government central bank erodes the value of every dollar in circulation. However, the modern monetary theory does not agree. As per them, in a free-floating fiat money economy like the United States, money creation would not raise prices. Therefore, unless the economy is close to reaching job growth and its maximum productivity potential, not considering M3 is justifiable.

In India, after Covid, the M3 money supply growth was seen. However, RBI measures it in a bit different way by using M1 and other components.

M3 = M1+ Time deposits with the banking system

Hence, M3 = Net bank credit to the Government + Bank credit to the commercial sector + Net foreign exchange assets of the banking sector + Government's currency liabilities to the public – Net non-monetary liabilities of the banking sector. 

In other words, banks' net Time Deposits are a component of M3, as are public currency notes and demand deposit balances maintained by banks. So M3 is the sum of M1 and bank time deposits.

Reserve Bank of India, which serves as the central bank of India, uses the M0 ratio to determine the money supply. The M0 ratio is between the M3 money supply and the RBI's reserve money.

This has been a guide to what is M3 Money Supply and its definition. Here, we explain it in the context of the M3 in USA and India with factors. You may learn more from the following articles –

• Fiat Money
• Paper Money
• Neutrality of Money