How is the money supply defined?

The money supply is defined as the quantity of money available to the economy, which encompasses all forms of money in circulation in a given period. This includes not only physical cash but also demand deposits, savings accounts, and other liquid assets that can easily be converted into cash.

A healthy understanding of the money supply allows economists and, by extension, policymakers to assess economic conditions, manage inflation, and implement effective monetary policy. For instance, if the money supply increases significantly, it might lead to inflation if it outpaces economic growth, while a decrease in the money supply could lead to deflation or economic stagnation.

The other options do not accurately reflect the comprehensive nature of the money supply. Specifically, foreign currency does not pertain to the domestic money supply, commodities relate to goods and services rather than financial liquidity, and cash held solely by banks doesn't account for the broader money circulation including that in public hands. Thus, the second choice correctly captures the essence of the money supply in relation to the overall economy.