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Sunday, March 28, 2010

Money Composition

Money quantity is the nominal value of particularly "liquid" financial instruments in an economy. "Liquidity" means that an asset is easy to sell in any moment with small or no losses in respect to nominal price

There exist a few definitions of money quantity, some broader than others, i.e. including a wider range of financial instruments.

For the following definitions, a series of simplification has been taken to keep things easy. Moreover, there exist significant international differences in definitions, especially for broader money definitions (M2 and M3).

The narrowest definition of money, the monetary base comprehends only cash outside banks plus bank reserves, the latter including both cash reserves held by banks and banks' deposits at the central bank.

Larger than the monetary base, M1 comprehends cash and current accounts in banks.

M2 is M1 plus the savings account.

M3 is M2 plus other liquid liabilities of monetary financial institutions.

Thus, although a largely accepted image of money doesn't associate it to interest-bearing, some definitions do comprehend interest-bearing assets.

A crucial distinction is between nominal and real quantity of money, the latter being equal to the former divided by price level. In this way, real money dynamics becomes dependent on inflation.

This is particularly important, since inflation, in its turn, is dependent on nominal and real quantity of money, too.

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