M1 and M2
What is M1 and M2?
M1 and M2 are money supply measures: M1 is currency plus checkable and savings deposits; M2 adds small time deposits and retail money market funds.
On the AP exam: AP Macro 4.3 Functions of Money
M1 covers currency held by the public, checkable (demand) deposits, and other liquid deposits, which include savings deposits. M2 is M1 plus small time deposits and retail money market funds, so every dollar in M1 is also in M2. The Federal Reserve has counted savings deposits in M1 since May 2020. Before that they were in M2 but not M1, which is why older textbooks show the earlier split.
M1 and M2: a worked example
A hypothetical economy reports currency held by the public of $220 billion, checkable deposits of $480 billion, savings deposits of $900 billion, small time deposits of $150 billion, and retail money market fund balances of $70 billion. M1 = $220 + $480 + $900 = $1,600 billion. M2 = M1 plus the two near money items, so M2 = $1,600 + $150 + $70 = $1,820 billion. Now households shift $50 billion out of savings and into checking. Both accounts sit inside M1, so M1 stays at $1,600 billion and M2 stays at $1,820 billion. Next, households cash in $30 billion of small time deposits and put the funds in checking. M1 rises to $1,630 billion, while M2 holds at $1,820 billion because those funds were already counted inside it. Vault cash and large time deposits belong to neither measure.
The mistake students make with m1 and m2
The frequent error is double counting, adding M1 to a list that already contains M1 and reporting an M2 twice as large as it should be. Write M2 as M1 plus near money, then add each near money item exactly once. Savings deposits are already inside M1, so they are not added again on the way to M2. The other classic slip is putting credit card limits in the money supply. A credit line is borrowing capacity, not an asset anyone holds, so it enters neither measure. Large time deposits also stay outside M2, which counts only small denomination time deposits.
M1 and M2 questions
What is the difference between M1 and M2?
M1 counts the most liquid money: currency held by the public, checkable deposits, and other liquid deposits such as savings deposits. M2 counts everything in M1 plus near money, meaning small time deposits and retail money market funds. Near money must be converted before it can be spent, and M2 can never be smaller than M1. With $1,600 billion of M1 and $220 billion of near money, M2 equals $1,820 billion.
Does moving money from savings to checking change M2?
Moving funds from a savings account into a checking account leaves both M1 and M2 unchanged. The Federal Reserve has counted savings deposits in M1 since May 2020, so the transfer only shuffles money between two components of the same totals. Under the older definition, still printed in many textbooks, savings deposits sat in M2 but not M1, so the same transfer raised M1 and left M2 flat. Today the move that raises M1 while M2 stays flat is cashing a small time deposit into checking.
Are credit cards counted in the money supply?
Credit cards count in neither M1 nor M2. A card gives access to a loan, and the money supply measures assets people hold, not borrowing capacity a lender has promised. When a purchase is charged, the card issuer pays the merchant with deposits that already exist, so no new money enters circulation. Debit cards differ, since they draw on a checkable deposit already counted in M1.
Formula / Example
The money market: money supply and money demand set the nominal interest rate. Tap it to drag the curves, open the full version, or put it on your own site free, or turn it into a five-minute class activity.
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