M3 Money Supply
What Is M3 Money Supply?
M3 is the broadest measure of money supply, including M2 plus large time deposits, institutional money market funds, short-term repurchase agreements, and larger liquid assets.
M3 Money Supply is the broadest classification of money supply used to measure the total amount of money within an economy. It includes all components of the narrower M1 and M2 measures—such as currency, checking accounts, savings accounts, and retail money market funds—and adds less liquid assets primarily held by large financial institutions and corporations. These additions include large time deposits (jumbo CDs), institutional money market funds, and short-term repurchase agreements (repos). Historically, M3 was used by economists to get a complete picture of the entire money supply, capturing not just consumer spending power but also the significant liquidity reserves of the financial sector. It serves as a measure of money as a store of value rather than just a medium of exchange. However, its importance has waned in official U.S. policy circles. The Federal Reserve discontinued publishing M3 data in 2006, stating that it did not convey any additional information about economic activity that was not already reflected in M2. Despite this, many private analysts and other central banks (like the ECB) continue to track M3 (or its equivalent) as a vital indicator of broad inflationary pressures and systemic liquidity.
Key Takeaways
- M3 encompasses M2 plus large time deposits and institutional money market funds.
- It captures the total liquidity in the economy, including assets held by large institutions.
- The Federal Reserve stopped publishing M3 data in 2006, deeming it less useful for policy.
- M3 is still used by some economists to track long-term inflation and institutional liquidity.
- It represents a store of value rather than just a medium of exchange.
How M3 Money Supply Works
M3 works by aggregating the most liquid forms of money with larger, less liquid financial instruments. While M1 and M2 focus on the money available to households and small businesses, M3 focuses on the wholesale money market. It captures the funds that banks and large corporations use for their operations and financing. When M3 is expanding, it suggests that financial institutions have ample liquidity to fund loans and investments, which can drive economic growth. Conversely, a contraction in M3 can signal stress in the banking sector or a reduction in credit availability for large borrowers. Because M3 includes assets that are not immediately spendable but act as significant stores of wealth, it is often seen as a long-term predictor of inflation trends, although its correlation with short-term economic variables is weaker than that of M2.
Components of M3
M3 builds upon the narrower money supply measures with specific institutional assets: 1. **M2:** All components of M2 (Currency, Demand Deposits, Savings, Retail Money Market Funds). 2. **Large Time Deposits:** Certificates of deposit (CDs) with large balances (typically over $100,000), often held by corporations and pensions. 3. **Institutional Money Market Funds:** Money market funds designed for large investors, offering slightly higher yields and lower liquidity than retail funds. 4. **Repurchase Agreements (Repos):** Short-term agreements to sell securities and buy them back at a higher price, used by banks to manage short-term capital. 5. **Eurodollars:** US dollar-denominated deposits held in banks outside the United States, used for international trade and finance.
Important Considerations for Investors
Although the Federal Reserve no longer publishes M3, understanding it helps investors grasp the full scope of global liquidity. For example, a surge in institutional money market funds or repo activity (components of M3) can indicate a "dash for cash" by large players during times of market stress. Furthermore, monitoring broad money aggregates like M3 is crucial for understanding the potential for asset price inflation. When there is excess liquidity in the institutional system, it often flows into financial assets—stocks, bonds, and real estate—rather than consumer goods, driving up asset prices even if CPI inflation remains low.
Real-World Example: M3 and the Housing Bubble
In the years leading up to the 2008 financial crisis, the M3 money supply was growing at a rapid pace, significantly faster than GDP. This explosion in broad liquidity was fueled by the creation of complex credit instruments and mortgage-backed securities, which acted as money-like substitutes for institutions. Private analysts tracking M3 saw this as a warning sign of a massive credit bubble. The excess liquidity was not showing up in consumer prices (CPI) but was inflating housing and stock markets. When the bubble burst, the "shadow money" components of M3 evaporated, leading to a severe liquidity crisis.
Why the Fed Discontinued M3
The Federal Reserve stopped publishing M3 in March 2006. The primary reason given was that the cost of collecting and processing the data outweighed the benefits. The Fed argued that M3 did not provide additional predictive power for the economy or inflation beyond what M2 already provided. Furthermore, financial innovation had made the distinctions between different types of large deposits less meaningful. Critics, however, argued that hiding M3 data reduced transparency regarding the total amount of dollar creation, especially during periods of quantitative easing.
Common Beginner Mistakes
Avoid these errors regarding M3:
- Looking for current M3 data on the Federal Reserve website (it is not there).
- Assuming M3 is irrelevant just because the Fed stopped tracking it.
- Confusing M3 with "money printing" (M3 includes credit creation, not just central bank base money).
- Thinking M3 affects daily consumer prices as directly as M1.
FAQs
The U.S. Federal Reserve does not calculate or publish M3 anymore. However, the OECD and other organizations (like the ECB for the Eurozone) still publish broad money measures comparable to M3. Some private economic research firms in the US also estimate M3 based on available data.
The main difference is the type of holder and asset size. M2 focuses on retail money—cash and savings held by individuals and small businesses. M3 includes M2 plus wholesale money—large time deposits and institutional funds held by banks, corporations, and pension funds. M3 is the "institutional" money supply.
Broad money measures like M3 have historically been linked to long-term inflation trends. According to monetarist theory, if M3 grows faster than output, inflation will follow. However, the link has weakened in modern economies, which is partly why the Fed shifted focus to interest rates and M2.
Eurodollars are U.S. dollar-denominated deposits held at banks outside of the United States. They are a component of M3 because they represent dollar liquidity available for global trade and finance, even though they are outside the direct US banking system.
M3 is called "broad money" because it casts the widest net, capturing highly liquid assets (cash) as well as illiquid assets (long-term deposits) that act as a store of value. It attempts to measure the total monetary resources available in the entire financial system.
The Bottom Line
M3 Money Supply represents the widest lens for viewing an economy's liquidity, capturing the vast pools of capital held by institutions and corporations. While it has fallen out of favor with U.S. policymakers, it remains a concept of great interest for understanding global liquidity, credit cycles, and asset inflation. For the sophisticated investor, understanding M3 provides insight into the "wholesale" side of money—the fuel that powers large-scale financial markets and banking operations—offering clues about systemic health that narrower measures might miss.
More in Monetary Policy
At a Glance
Key Takeaways
- M3 encompasses M2 plus large time deposits and institutional money market funds.
- It captures the total liquidity in the economy, including assets held by large institutions.
- The Federal Reserve stopped publishing M3 data in 2006, deeming it less useful for policy.
- M3 is still used by some economists to track long-term inflation and institutional liquidity.