Narrow Money

What is Narrow Money?

Narrow money is a way of measuring and categorizing the money supply within an economy. It includes specific kinds of money that are highly liquid. Due to its liquidity, it is easily accessible and can be used for immediate spending.

Some examples include cash or checkable deposits. It is important to note that foreign currency, however, is not included in narrow money. Narrow money can also be known as M1.

Money supply is measured and categorized on a scale from narrow to broad. Although the classification does vary depending on the country, it is typically classified through an “M” scale, where M0 includes the narrowest forms of the money supply, and M4 includes the broadest forms of the money supply. M0 is an even more narrow form of narrow money (M1), but its classification is only used in some countries.

The United States, for example, does not use M0 or M4 in its classification. They use M1-M3 only, with M1 including all forms of narrow money. In this case, M1 includes more liquid money, such as coins or notes. On the other hand, M2 or M3, such as money market funds, are less liquid.

In the U.S., M2 and M3 are defined as broad money, and M3 includes the broadest form of an economy’s money supply. It is important to note that the M1 money supply is included within the calculation of the M2 and M3 money supply, but not vice versa.

What is Broad Money?

Broad money is the secondary component of measuring the money supply. Although it does include all forms of narrow money, it includes additional forms that are less liquid. Typically, broad money is known as M2, M3, or M4.

When measuring the money supply, broad money is the most flexible and inclusive method. Interestingly, there is still some liquidity to broad money, as it includes forms of money that can be turned to cash within a short period of time – for example, Treasury bills.

Narrow Money and Broad Money

Narrow money is a subset of broad money. To be explained further, in the United States, narrow money is solely known as M1, whereas broad money includes M1, M2, and M3. As you can see in the explanation below, M1 examples (narrow money) are also included in the M2 and M3 examples (broad money).

M1 Examples: Notes and coins

M2 Examples: Notes, coins, traveler’s checks, and demand deposits

M3 Examples: Notes, coins, traveler’s checks, demand deposits, savings deposits, and money market deposits

Importance of Narrow Money

Narrow money is important because it is used as a way to measure and analyze the money supply within an economy. The amount of narrow money can help in understanding how a country is performing economically. Therefore, it is vital to understand the difference between broad and narrow money when calculating the total money supply.

It is important to recognize which portion of the money is narrow and which portion is broad since broad money is not as liquid, and therefore, not readily available for spending. Furthermore, knowledge of how much narrow money is in circulation is important for monetary policy, as it can potentially help aid in managing and foreseeing changes in inflation or interest rates.

Examples of Narrow Money

1. You have a quarter in your pocket. It is highly liquid and can be used right away.
2. You have $50 in your wallet. It is highly liquid and can be used right away.
3. You have $500 in your checking account that is liquid and can be turned into currency immediately by withdrawing it from a bank or ATM. This example includes money that is not as narrow or liquid as the first two examples since it is not readily available.
4. You have a traveler’s check for $100 that is liquid and can be turned into currency right away if you cash it at the bank. This example includes money that is not as narrow or liquid as the first two examples since it is not readily available.

Related Readings

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Cash Equivalents
• Monetary Policy
• Money Neutrality
• Monetary Base
• See all economics resources