M0 is not Off-Ledger
The terms M0, MB, M1, M2, and M3 (also known as ‘currency aggregates’) refer to different measures of the currency supply in an economy. These measures provide a way to quantify the amount of currency available in an economy at a given point in time and are typically used by economists and policymakers to understand economic conditions and guide monetary policy.
Here's a brief explanation of what each of these measures includes:
- M0: M0 includes liquid currency in circulation. It includes coins, paper money, and other forms of currency that are in circulation but not held by the government or financial institutions. M0 also includes central bank reserves, which are the deposits that commercial banks hold with the central bank.
- MB (Monetary Base): The Monetary Base also known as Narrow Currency, includes currency in circulation (coins and banknotes) and reserves held by commercial banks at the central bank. In some definitions, it might also include vault cash — money kept in the vault of commercial banks.
- M1: M1 includes all of M0, plus other assets that are nearly as liquid as cash. Specifically, M1 includes checking accounts (funds in current accounts that can be withdrawn at any time without any notice) and other demand deposits. In essence, it includes all funds that are readily accessible for spending.
- M2: M2 includes everything in M1, plus other types of deposits that are less immediately accessible. Specifically, M2 includes savings accounts, money market accounts, and small-denomination time deposits (certificates of deposit that are below a certain size, often $100,000). These are forms of money that can be converted into cash relatively easily, but not as quickly or conveniently as the components of M1.
- M3: M3 includes everything in M2, plus large time deposits, institutional currency market funds, short-term repurchase agreements, along with other larger liquid assets. These are types of currency that are less liquid than those included in M2, but still contribute to the total amount of currency available in the economy.
Each of these measures provides a different perspective on the currency supply, and each can be useful for understanding different aspects of the economy. M0 and M1, for example, are often used to analyze the most immediate forms of liquidity in the economy, while M2 and M3 are used to understand broader trends in the currency supply.
It's important to note that the exact definitions of these measures can vary between different countries.
Off-Ledger/Balance
To understand what off-ledger is, please read here
The Physical Reality of M₀
Understanding why it cannot be electronically transferred
The term M₀ refers to the monetary base or base money, which encompasses physical currency in circulation (banknotes and coins) as well as reserves held by commercial banks at the central bank. Understanding why M₀ cannot be transferred by a bank electronically but must instead be physically moved requires a deeper appreciation of its unique properties and the operational framework of modern monetary systems.
Key Characteristics of M₀
1. Physical Composition
- A large portion of M₀ consists of tangible cash (notes and coins). Unlike electronic deposits or digital money, which exist as entries in banking systems, this portion of M₀ is inherently physical and must be physically handled to change possession.
2. Bearer Nature of Physical Cash
- Cash, as a bearer instrument, means that ownership is determined by possession. Transferring physical cash from one entity to another requires the physical handover of the cash itself.
3. Reserve Component
- The second component of M₀ includes reserves held by commercial banks at the central bank. While reserve balances can be adjusted electronically (e.g., through central bank clearing mechanisms), the cash portion must adhere to its physical constraints.
Why M₀ Cannot Be Electronically Transferred
1. Physical Constraints of Cash
- Banknotes and coins, which form a substantial part of M₀, exist outside the digital framework of the banking system. Transferring cash entails physical delivery—such as between banks, branches, or ATMs—since it cannot be represented digitally while retaining its status as legal tender.
2. Design of the Banking System
- The monetary system is structured to distinguish between physical currency and digital money. While digital transactions (e.g., deposits or electronic funds) involve updates to account ledgers, M₀’s physical cash must be physically moved to complete transactions.
3. Ownership and Settlement
- Unlike digital money, which relies on trust in banking records, ownership of physical cash depends solely on who holds it. Thus, transferring cash (M₀) necessitates physical transportation to ensure ownership changes.
4. Operational Framework
- Even though central bank reserves (part of M₀) can be electronically adjusted through settlement systems, the physical currency component cannot be moved in this manner. When physical cash is required, it must be physically withdrawn and transported.
Examples of Physical Movement of M₀
1. Interbank Cash Transfers
- When one bank needs to supply physical cash to another, armoured vehicles physically transport the banknotes and coins. This is often required during periods of high demand for cash (e.g., holidays).
2. ATM Replenishment
- Banks must physically stock ATMs with cash to meet customer withdrawal needs, involving significant logistical effort and security measures.
3. Business Cash Needs
- Businesses, particularly those in retail or cash-intensive sectors, often require large quantities of physical currency. Banks must arrange for the safe delivery of this cash.
Reducing the Need for Physical Movement of M₀
1. Promoting Digital Transactions
- By encouraging electronic payments and digital banking, reliance on physical cash can be reduced, minimising the logistical challenges of moving M₀.
2. Cash Recycling
- Banks can optimise cash recycling at local branches and ATMs, where deposited cash is reused for withdrawals, reducing the need for physical transport.
3. Developing Central Bank Digital Currencies (CBDCs)
- CBDCs could potentially represent M₀ in a fully digital form, allowing for electronic transfer while retaining the central bank’s backing. This would diminish the need for physical cash entirely.
Challenges and Probabilities
1. Transition to a Cashless Economy
- Probability: High in advanced economies with mature digital infrastructure.
- Challenges: Resistance from populations reliant on cash and sectors where cash is still dominant.
2. Physical Cash Dependency
- Probability: High in the short term, particularly in emerging economies or during crises (when cash demand surges).
- Challenges: Balancing the reduction of cash dependency with ensuring financial inclusion.
3. Implementation of CBDCs
- Probability: Medium to high as central banks globally experiment with CBDCs.
- Challenges: Technical, regulatory, and societal acceptance hurdles.
In summary, M₀ cannot be transferred electronically due to the physical nature of cash and its operational framework within the banking system. While digital solutions and innovations like CBDCs may reduce reliance on physical cash, the movement of M₀ will remain a logistical reality as long as physical currency retains its critical role in the economy.
