Question

The money supply (Ms) in the economy is defined as the circulation of money (that consists of currency coins, paper notes, and bank balances) in the economy. Alternatively, the money supply refers to the safe assets that individuals and businesses hold for the purpose of either making payments or short-term investments.
The central bank in the economy has developed various measures of money of which the M1 and M2 are two measures. The M1 is the most liquid measure of money and is comprised of the currency, traveler’s check, and checking account deposits. Mathematically, M1 is derived as:

M1 = Currency + traveler check + checking account deposits.

The M1 is the most liquid form of money since the components included in it are easily convertible into cash without a loss in their original value.

M2 is a relatively broader measure of Ms but is also a relatively less liquid measure compared to M1. This is because M2 consists of currency, traveler’s checks, checking deposits, savings accounts, and money market mutual funds. As such, M2 is the sum of M1 and savings accounts and money market deposits. Mathematically, M2 can be described as:

M2 = M1 + savings accounts deposits + money market mutual funds.

Mutual funds are components of the M2 money supply while checking account balances are the components of the M1 money supply. When $2,000 are taken away from the mutual funds and deposited in the checking accounts, there would be an increase of $2,000 in the M1 money supply since the checking account component of M1 would increase by $2,000.

However, there would be no change in the M2 money supply because the withdrawal of $2,000 from the mutual funds would decrease the M2 by $2,000 initially. However, when this $2,000 amount is kept in the checking account, the M1 increases, and since M1 is also included in M2, M2 will increase by $2000. As such, the net effect in the M2 measure would be zero.

Answer 1

As the money supply consists of both currency & balances in different accounts, it is used by top financial institution to make economic decisions.

What is a money supply?

This refers to the total amount of money such as cash, coins, balances in bank accounts that are in circulation in a year.

M1

The M1 means the most liquid money that comprised of the currency, traveler’s check, and checking account deposits.

• M1 = Currency + traveler check + checking account deposits.

M2

The M2 is broader measure of Ms although it is has a less liquid measure compared to M1 and consists of currency, traveler’s checks, checking deposits, savings accounts, money market mutual funds etc

• M2 = M1 + savings accounts deposits + money market mutual funds.

M3

The M3 is broader measure of Ms as it includes M2 money as well as large time deposits, institutional money market funds, short-term repurchase agreements, larger liquid funds etc.

• M3 =  M1 + Time deposits with commercial banks (Fixed deposits, Recurring deposits).

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