Currency in Circulation vs Vault Cash
Currency in Circulation and Vault Cash are two Money & Monetary Policy concepts in AP Economics that students often mix up. Currency in circulation is the physical cash held by the public outside banks; it counts in M1, while cash sitting in bank vaults does not. Vault cash is the physical currency a bank keeps on its premises; it counts toward the bank's reserves alongside its deposits at the Fed. Here is how they compare side by side.
Only currency in the hands of households and firms is part of the money supply, vault cash and Fed-held cash are excluded. Currency in circulation plus bank reserves makes up the monetary base. A common exam point: most of M1 is checkable deposits, so currency is only a small slice of the total money supply.
A bank's total reserves equal its vault cash plus its deposit balances held at the Federal Reserve. Vault cash lets banks meet day-to-day withdrawals and, together with Fed deposits, determines whether the bank is holding required reserves and any excess reserves. On the AP exam, remember that vault cash is an asset of the bank but is NOT counted in M1 (currency in circulation excludes cash sitting in bank vaults).
Currency in Circulation vs Vault Cash: The Same Notes, Counted Differently
| Currency in Circulation | Vault Cash | |
|---|---|---|
| Who is holding the notes | The public, outside the banking system | A bank, on its own premises |
| Counted in M1 | Yes | No |
| Counted as bank reserves | No | Yes |
| Can it support new lending | No | Yes, once it exceeds required reserves |
| What a cash deposit does to it | Falls by the amount deposited | Rises by the same amount |
| Why the distinction exists | Counting both would double count the same notes | Reserves are what a bank can pay out or lend against |
Depositing cash moves the notes between categories without creating money
A customer walks $1,000 of banknotes into a bank and deposits them. Three things happen at once. Currency in circulation falls by $1,000 because the public no longer holds those notes. The bank's vault cash rises by $1,000, and since vault cash counts as reserves, its reserves rise by the same amount. Checkable deposits rise by $1,000. Add up the effect on M1 and it is exactly zero, because the currency component fell by $1,000 while the deposit component rose by $1,000. No money was created by the deposit itself. What happens next is where money is created. Under an illustrative 10 percent required reserve ratio, the bank must keep $100 against the new deposit and the other $900 becomes excess reserves it is free to lend. Lend it, and the borrower spends it, and the receiving bank keeps a tenth and lends the rest, and the chain continues. Across the system, deposits can rise by up to $900 times 10, which is $9,000. So M1 rises by nothing on the day of the deposit and by as much as $9,000 afterwards. The full chain is worked through at /calculate/maximum-checkable-deposit-expansion.
The line exists to stop the same banknote being counted twice
Money supply measures are meant to count purchasing power available to the public, so a note sitting in a bank's drawer cannot count. If it did, a deposit would appear to create money out of nothing, since the note would show up as currency and the matching deposit would show up as well. Excluding vault cash from /glossary/m1-and-m2 keeps the accounting honest. The same note is treated differently for a second measure. The monetary base counts currency held by the public plus total bank reserves, and vault cash belongs to the reserve half, so a cash deposit leaves the base unchanged even as it lowers the currency component. Two measures, one note, two answers, and both are correct because they are asking different questions. One asks what the public can spend, and the other asks how much raw material the banking system has to build on. This is worth rehearsing before an exam, because questions about cash deposits and withdrawals are designed to see whether you can keep the two accounts separate rather than to test any calculation.
Frequently asked questions
Is vault cash part of M1?
No, only currency held by the public outside banks counts in M1, so cash sitting in a bank's vault is excluded. Including it would double count the same banknotes, since the deposits those notes back are already counted in M1.
Does vault cash count as reserves?
Yes, a bank's reserves are its vault cash plus the balances it holds in its account at the central bank. Both can be used to meet withdrawals and both count toward any reserve requirement, which is why moving notes between the vault and the central bank account changes nothing for the bank's reserve position.
What happens to the money supply when someone deposits cash?
Nothing changes immediately, because currency in circulation falls by the amount deposited while checkable deposits rise by the same amount, leaving M1 flat. The money supply grows only afterwards, as the bank lends out the excess reserves the deposit created and the lending chain works its way through the banking system.
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