Video transcript
What I want to explorein this video is the different ways ofmeasuring the amount of money we have in circulation. So we're going to startthings with our Central Bank in the US. This would be theUS Federal Reserve. And let's say thatthey print $4. And we're going to focus, justfor visualization purposes, on that they'redoing it physically. They could also doit electronically. But we're just going tofocus on the physical. And the way that theyget this into circulation is it they'll takethese $4 and they'll go buy securities in theopen market, normally very safe and veryliquid securities. Liquid means it's veryeasy to buy and sell those securities inlarge quantities. For example,government treasuries is a liquid security,or liquid asset. PEZ dispensers wouldnot be a liquid asset. If I bought a billiondollars worth of PEZ dispensers it would be veryhard for me to sell-- one it would be very hard for meto buy a billion dollars worth. And it would be evenprobably even harder for me to sell a billion dollarsworth in any short or medium timeframe. So the Central Bank goes out,and let's say they go and buy one liquid security for $4. So this is a securityright over here. And the person that theybought the security from decides to deposit it in a bank. They could either directlydeposit it in a bank or they could usethat money that they got from selling theirsecurity to buy things, and the person theybought things from could deposit it in a bank. But one way or another wecan imagine it all gets deposited in a bank. So this is our private bank. I'll call this privatebank number one. So now all of thesedollars are transferred to private bank number one. And they are no longer--the Federal Reserve, or the Central Bank,in the general case, is no longer inpossession of them. They've been transferredright over here. And I want to crossthese out just so we can keep track of things. Now when they deposit itin private bank number one, they said, well, I need threeof these dollars on demand. And I want to writechecks against them. So they put three of thesedollars in a checking account. There are at three of thesedollars a checking account. So checks up too-- sowrite checks up to $3. And so they can get alittle bit more interest, and the bank's willing to givea little bit more interest on a savings accountbecause they don't have to keep the reserves, theyput $1 into a savings account. And they cannot write checksagainst that savings account. Now there are specialcirc*mstances now, but for simplicity, let's justsay that they cannot write checks. There are some that haverestricted check writing and things like that now. So this bank says, OK,well, this dollar, I don't have to even haveany reserves against it. I could loan out this dollar. And the person theylend it to, let's say that they immediately go anddeposit it into another bank. So they immediately go anddeposit this in private bank, I'll call this private bank two. So it's no longerin private bank one. Let me draw a private bank two. Private bank two isa right over here. Private bank number two. And they deposit itinto a savings account in private bank number two. And let's say all ofthis, out of all of this, the bank says, well,this is a demand deposit, I have to keep some reserves. This is a fractionalreserve system. But I can lend out, in theUS, I could lend out up to 90% of this. And maybe this bank is alittle bit more conservative, They only lend out 2/3 of this. So they lend out$2 out of these $3 And let's say the personthey let it do also happens to deposit itin private bank number two, just coincidentally. So these two also end upin private bank number two. And so they're no longerin private bank number one, although this person couldstill write checks up to $3. And now here inprivate bank number two-- and let's saythese are deposited in a checking account. These are deposited right overhere in a checking account. Now private bank number two,it can do a couple of things. In this checking account ithas to keep some reserves. Let's say it's evenmore conservative. It only decides tolend out half of this, even though itcould lend out 90%. And so it lends outone of these dollars. And the person that they lendit to just takes that dollar and they put it in their wallet. So they just putit in their wallet. And they could also lendout this entire savings. And let's just saythat the person that they lend that$1 in savings to also puts it in their wallet. And notice, the original$4 are still there. One, two, three, four. Now, and just to be clear,this person right over here can write checks up to $3 . And this personright over here can write checks-- let me dothat same checking account color-- they canwrite checks up to $2. Now let's think about thedifferent forms of money there are here. Well, we could think of money ina very, very narrow way, which is just what did the CentralBank print, or create electronically as electronicreserves of its member banks? But for simplicityhere you can just think about the physicalcurrency that it printed, its base money. And so that, often, is justreferred to as base money. And in the US andother countries it's often the same thing as M0. There's slight differencesfrom country to country. And in this example, as soonas they printed it and put it into circulation, that was $4. We had $4 of base money. And that's obvious becauseas soon as they printed this and they bought thesecurity with it, and it was in circulation, that$4 could be used to buy things. It could be used tofacilitate transactions. Now that clearly isn'tall of the stuff that can be used as money in thislittle universe we created. This guy, you have the$4 but these people can also write checksright over here. And so we can have a slightlybroader definition of money. And over here, wewill call it M1. And here, there's a couple ofways you could think about it. You could think about it asall of the currency that's in people's pockets plus all ofthe check writing capabilities. So if you view itthat way it, would be this $2 plus $5 ofcheck writing capabilities right over here. So you could have $2of physical currency that's in people's wallets,not in bank reserves, plus the $5 of checkwriting capability, which would give you $7. Another way youcould view it, you could view it as M0plus checkable deposits. I'll just write checkshere, plus-- well I'll write-- checkable deposits. But if you do that,you are now double counting becausesome of the M0 is reserves in thecheckable deposits. Or you could say some ofthe checkable deposits is held as reserves for M0. So then you would have tosubtract out the bank reserves. And so then you wouldget $4 because we don't want to double countthese right over here. You would get M0 is $4. And I want to do that in white. M0 is $4. The checkable deposits is $5. Let me do that in the pink. Plus the $5. And then you would want tosubtract out the reserves. And the reserves here, thereare $2 of the reserves. So minus $2. And you would getyourself back to the $7. And the whole point of this isso you're not double counting something, you're not doublecounting this right over here, as part of checkabledeposits and part of the M0. You're not using this twice. It's not part of the base money. It is both the base moneyand checkable deposits. And we don't wantto count it twice. So the simplestway to think about is, well, what can be usedin this broader definition to facilitate transactions? These $2 in people'spockets, and this ability to write up to $5 of checks. So that's this viewright over here. And if we want to geteven broader than that, we can get tosomething called M2. And here we could say,OK, what's immediately usable to facilitate atransaction right now? So that would be our M1. So that would be our $7 of M1. Plus things that can beeasily converted to M1. So for example, thesesavings accounts can be easily convertedto checking accounts. It might only takea couple of days. There might besome restrictions. But it can be converted. And when it gets convertedwill change the bank's reserve requirements a little bit. But it will allow, ifthis person converts it they will have the abilityto write more checks. So M2 includes M1plus things that are very easy to convert to M1. And so they'll include thingslike savings accounts, money market accounts, which Iwon't go into detail here. But they're really kindof similar in that you get slightly higherinterest, but there are restrictions on yourability to access it. But it's not too hard to turnit into checking accounts. And small dollar valuetime deposit, CD accounts. But for the sake ofsimplicity, in this example, it would be the saving accounts. So it would be our$7 of M1, plus the $2 of savings accountsright over here. So this is just togive you a picture. When someone talksabout the money supply you reallyhave to say, well, what are you talking about? The most typical one is thatyou're really talking about M1, because this is the stuff that'sdirectly usable to facilitate transactions. Things like the abilityto write a check, or dollar bills insomeone's wallet. But they might be talking aboutbase money, M0, narrow money, always of referringto the same thing, especially in the United States. Or they might be referringto something even broader. And there arebroader definitions even than M2,although M3, they've stopped reporting about it. But M3 would have thingsthat are a little bit further from being true money, frombeing a checking account. But they are alreadyfairly liquid and so they'll includeother types of assets. But the Fed hasstopped reporting this in the recent past. So these are the ones thatare typically referred to.
