Reviewed by Sep 30, 2020| Updated on
Broad money is a concept for measuring how much money circulates in an economy. It is defined as the most comprehensive method of calculating the money supply of a given country, the totality of assets that can be used by households and businesses to make payments or keep as short-term investments, such as currency, funds in bank accounts, and anything of money-like value.
Since many different financial instruments can be exchanged for cash and placed in different restricted accounts, it is not a simple task for economists to define how much money circulates in any economy at the moment. Therefore, the supply of money is calculated in different ways.
The method of computing money supply varies from country to country, but broad money is always the most far-reaching, encompassing all highly liquid assets, currency, and checkable deposits, called "narrow money," along with somewhat more illiquid forms of capital.
Broad money generally also accounts for "near money," such as deposit certificates (DCs), foreign currencies, money market accounts, marketable securities, Treasury bills (T-Bills), and anything else that can easily be converted into cash, excluding company shares.
There are several advantages to widening the scope of the total money in circulation. Above all, it lets policymakers get a better understanding of future inflationary trends—how much goods and services' prices are likely to increase. Next to narrow money, central banks also look at wide money to decide which monetary policies are needed at any given moment to keep the economy in check.
Economists have established close links between the supply of money, inflation, and interest rates. Central banks, such as U.S. Federal Reserve, use lower interest rates to increase the money supply when the goal is to stimulate the economy.
Conversely, interest rates are increased in an inflationary environment when the money supply is declining, resulting in lower prices.
In short, the economy tends to accelerate if more money is available because businesses have easy access to finance. If the system contains less money, the economy slows down, and prices can drop or stall. In this context, broad money is one of the measures used by central bankers to determine what interventions they could introduce, if any, to influence the economy.