The money supply is traditionally defined as cash in circulation outside the banks, plus bank deposits. But as the banking and financial system evolved so did the types of deposits issued to the non-bank public. Now there are questions about the measurement of money supply.
In the early days of banking there were demand deposits on which cheques could be written and savings deposits which often required a period of notice before funds could be withdrawn. Today banks offer a much wider spectrum of deposits to customers from demand to savings deposits that may or may not be chequable, pay interest under different terms, and some which can only be accessed online. Not all deposits serve as means of payment. For these the balance must be transferred to another account before it is available to make a payment. Which deposits should be counted in the money supply?
The structural evolution of the financial system raises further questions. What is a ‘bank’? Today banks compete vigorously for deposits with other businesses, including trust companies and credit unions whose deposits are widely accepted as means of payment. There is no longer a reason to exclude those deposits from measures of the money supply. Different measures of the money supply illustrate the importance of different financial institutions in the industry.
The Bank of Canada now publishes data on the monetary base in response to continuing changes in the types of bank deposits available to households and businesses. Advances in technology, financial deregulation, and competition in the financial services sector, which have led to more types of financial assets, make it easy for customers to substitute between those assets we include in narrow definitions of money supply and other assets. But once we leave the monetary base as a measure of money supply, there is no single measure of money that is clearly the means of payment. There is however only one type of money that is legal tender namely notes and coin.
Monetary base: legal tender comprising notes and coins in circulation plus the cash held by the banks.
Table 8.1 shows the size of the money supply in Canada based on different definitions and money aggregates. These data illustrate the range of choice involved in the selection of a specific measure of the money supply. But one thing is clear. Bank deposits are the major component of money supply by any measure other than the currency component of the monetary base.
Table 8.1: The money supply in Canada in February 2014 ($ billions)
Source: Statistics Canada, CANSIM Table 176-0025. Revised 26/10/2014.
Currency in circulation is only about 5 percent of M2. Deposits account for the remaining 95 percent. The importance of bank deposits as money means that understanding the operations of banks as sources of loans and deposits is the key to understanding the money supply function in the economy.