Difference Between Broad Money And Narrow Money

Difference Between Broad Money And Narrow Money

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Rashmi
Rashmi Karan
Manager - Content
Updated on Jan 8, 2024 13:56 IST

Broad and narrow money are two concepts used in economics to describe different measures of the money supply in an economy. The article explores the concepts of broad and narrow money and covers the difference between broad money and narrow money and how they affect the economy.

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Think of Narrow Money as the money in your pocket – the cash you carry and your easily accessible bank account balance. It's quick and easy to use, perfect for buying that ice cream you wanted after lunch. Now imagine your piggy bank with all your savings. It may take longer to break it open and use the money, but it's there for bigger things like your new bike, this is Broad Money. 

Comparison Table – Broad Money vs Narrow Money

The key difference between broad money and narrow money is that while narrow money is highly liquid and can be easily used for transactions, broad money includes all types of money in an economy and reflects the total value of money available to individuals and businesses.

  Broad Money Narrow Money
Definition  Refers to all forms of money in an economy, including less liquid ones, such as savings accounts and other bank deposits. Refers to the most liquid forms of money, easily and readily available for spending
Indicated as  M3 and M4 M1
Liquidity  Low liquidity  High liquidity
Economic Assessment Used to assess overall economic liquidity and financial stability Focuses on short-term spending power and immediate liquidity conditions
Sensitivity to Changes Less sensitive to short-term changes in consumer spending patterns More directly linked to changes in consumer spending and confidence
Examples
  • Currency
  • Deposits with a maturity of up to two years
  • Deposits are redeemable at notice of up to three months
  • Repurchase agreements
  • Money market fund shares/units
  • Debt securities for up to two years
  • Physical currency and coins in circulation
  • Demand deposits
  • Traveller’s checks
  • Other liquid assets
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What is Narrow Money?

Narrow money, also known as M1, refers to the portion of a country’s money supply readily available for transactions. It typically includes physical currency and demand deposits held by banks. In the global market, narrow money is a key indicator of economic activity and monetary policy

Central banks closely monitor and control the growth of M1 through various policy tools such as setting interest rates, reserve requirements, and open market operations.

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What is the Role of Narrow Money on Economies?

The role of narrow money in economies is multi-faceted and includes the following:

  1. Measuring liquidity: Narrow money is a key indicator of an economy’s liquidity. It reflects the amount of money available for immediate spending, popularly known as liquidity. Central banks use narrow money to measure the economy’s health and adjust monetary policy accordingly.
  2. Controlling inflation: Narrow money supply can impact inflation rates. An increase in narrow money can lead to inflation, while a decrease can result in deflation. Central banks use narrow money to manage inflation rates by controlling their supply.
  3. Stimulating economic growth: An increase in narrow money can increase demand for goods and services, thereby boosting economic growth. Central banks can use narrow money to stimulate economic growth by increasing the supply.
  4. Managing interest rates: Narrow money also plays a crucial role in managing interest rates. Central banks can influence interest rates by adjusting the supply of narrow money. A decrease in a narrow money supply can lead to higher interest rates, while an increase can result in lower interest rates.
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What is Broad Money?

Broad money refers to the total amount in an economy, including narrow money (M1) and other types of assets, such as savings accounts, time deposits, and other financial instruments. It is also known as M2 and is a crucial indicator of an economy’s overall liquidity and the effectiveness of its monetary policy.

What is the Role of Broad Money on Economies?

In the global market, broad money plays a vital role in measuring the overall health of an economy. 

  • By managing the growth of broad money, central banks can influence inflation, exchange rates, and overall economic growth.
  • Less-liquid assets aren’t easily convertible to cash and can’t be used immediately if needed.
  • Economists have long used M3 to estimate an economy’s total money supply and central banks. This helps to drive monetary policy to regulate inflation, consumption, growth, and liquidity over medium and long periods.
  • According to economists, money supply, inflation, and interest rates are all linked. The Reserve Bank of India utilizes lower interest rates to stimulate the economy to expand the money supply.
  • The economy tends to accelerate when more money is available because firms have easier access to capital.
  • The economy slows, and prices may fall or halt if there is less money in circulation.
  • Central banks can promote stable economic growth and manage inflation by measuring and managing broad money, making broad money a critical factor in the global economy and financial markets.
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In summary, narrow money represents the most liquid and easily accessible form of money in an economy. In contrast, broad money represents the total value in an economy, including less liquid forms that may not be readily available for spending.

FAQs

What is the significance of measuring the money supply?

Measuring the money supply is important for understanding the overall health of an economy and can help policymakers make informed decisions about monetary policy, interest rates, and other economic factors.

How is Narrow Money different from M1?

M1 measures the money supply that includes only physical currency and demand deposits, whereas narrow money includes only physical currency and demand deposits.

What is the importance of broad money?

Broad money is important because it measures the overall liquidity of an economy, facilitates economic growth, and impacts inflation, interest rates, and exchange rates.

What is the relationship between broad money and the economy?

The level of broad money in an economy can impact inflation and economic growth. Higher levels of Broad Money can lead to inflation, while lower levels can lead to slower economic growth.

What is the relationship between narrow money and the economy?

Narrow money is a key indicator of an economy's liquidity level and can impact interest rates and credit availability.

About the Author
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Rashmi Karan
Manager - Content

Rashmi is a postgraduate in Biotechnology with a flair for research-oriented work and has an experience of over 13 years in content creation and social media handling. She has a diversified writing portfolio and aim... Read Full Bio