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Official Measures of Money: M1 and M2

CFA® Exam, CFA® Exam Level 1, Economics

This lesson is part 4 of 20 in the course Monetary and Fiscal Policy

There are two official measures of money known as M1 and M2.

According to New York Fed:

“The money supply measures reflect the different degrees of liquidity—or spendability—that different types of money have. The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the public; travelers checks; demand deposits, and other deposits against which checks can be written. M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds.”

These two forms of money are summarized in the below table:

  M1 M2
Currency and traveler’s checks Yes Yes
Checking deposits Yes Yes
Time deposits   Yes
Savings deposits   Yes
Money market mutual funds and other deposits   Yes

The European Central Bank has defined a narrow aggregate (M1), an “intermediate” aggregate (M2) and a broad aggregate (M3). These aggregates differ with regard to the degree of moneyness of the assets included. The following table summaries this:

M1

M2

M3

Currency in circulation X X X
Overnight deposits X X X
Deposits with an agreed maturity up to 2 years   X X
Deposits redeemable at a period of notice up to 3 months   X X
Repurchase agreements     X
Money market fund (MMF) shares/units     X
Debt securities up to 2 years     X

Quantity Theory of Money

The quantity theory of money states that the money supply has a direct relationship with the price levels.

If P is the price levels, and Q is the real output, then P*Q is the total spending. If M is the money supply, then:

M*V = P*Q

V is the velocity, that is, the number of times each unit of money is used to buy goods and services.

This equation is called the equation of exchange.

This equation helps us understand the relationship between money supply and price levels. Assume that the real output and velocity remains constant, a 10% increase in money supply will result in a 10% increase in average price levels. This is the reason why monetarists believe that monetary policy can be used to control inflation.

Previous Lesson

‹ How is Money Created?

Next Lesson

Demand and Supply of Money ›

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In this Course

  • Mechanics of Monetary and Fiscal Policy
  • What is Money?
  • How is Money Created?
  • Official Measures of Money: M1 and M2
  • Demand and Supply of Money
  • Fisher Effect
  • What do Central Banks do?
  • Tools for Implementing Monetary Policy
  • Features of Effective Central Banks
  • The Monetary Policy Transmission Mechanism
  • Expansionary vs. Contractionary Monetary Policy
  • Limitations of Monetary Policy
  • Role of Fiscal Policy
  • Tools of Fiscal Policy
  • Fiscal Multiplier and Balanced Budget Multiplier
  • Ricardian Equivalence
  • Should We Worry About the Size of Fiscal Deficit?
  • Challenges in Implementing Fiscal Policy
  • Expansionary Vs. Contractionary Fiscal Policy
  • Combined Effects of Monetary and Fiscal Policy

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