Cash in a wallet, coins in a jar, balances in a checking account, savings deposits, money market funds. All of these are part of the money supply, the total amount of money circulating in an economy at a given time. Economists divide it into categories. M1 includes the most liquid forms: physical currency and checking deposits. M2 adds savings accounts and small time deposits. M3, no longer tracked by the Federal Reserve, included large institutional funds.

Why does the money supply matter? Because it affects prices, interest rates, and economic activity. If the money supply grows faster than the economy's output, inflation tends to follow. If it shrinks, deflation and recession can take hold. The relationship is not mechanical, but it is real. Milton Friedman famously argued that inflation is always and everywhere a monetary phenomenon.

Central banks influence the money supply through their policy tools. When they buy bonds, they inject money into the banking system. When they sell, they drain it. Commercial banks also create money when they make loans, since a loan becomes a deposit somewhere else. That multiplier effect means the central bank does not control the money supply perfectly, only nudges it.

Money aggregates

• M0: physical currency and central bank reserves
• M1: currency plus checking deposits
• M2: M1 plus savings and small time deposits
• M3: M2 plus large institutional funds