Question

For each of the following transactions, what is the initial effect (increase or decrease) on M1? On M2? a. You sell a few shares of stock and put the proceeds into your savings account. b. You sell a few shares of stock and put the proceeds into your checking account. c. You transfer money from your savings account to your checking account. d. You discover \(\$ 0.25\) under the floor mat in your car and deposit it in your checking account. e. You discover \(\$ 0.25\) under the floor mat in your car and deposit it in your savings account.

Short answer

Answer: Transferring money from a savings account to a checking account causes an increase in M1, as checking accounts are part of M1. There is no overall change in M2, as the total amount of money hasn't changed, just its allocation within M2 components.

Step-by-step solution

a. Selling stock and putting proceeds into savings account

Neither M1 nor M2 is affected by selling the stock, as stocks are not considered part of the money supply. However, when the proceeds are deposited into a savings account, it will cause an increase in M2 since savings accounts are part of M2 but not M1. So, there is no effect on M1 and an increase in M2.

b. Selling stock and putting proceeds into checking account

Selling the stock does not affect either M1 or M2. When the proceeds are deposited into a checking account, this will increase both M1 and M2, as checking accounts are part of M1, and by extension, part of M2.

c. Transferring money from savings account to checking account

When transferring money from a savings account to a checking account, you are moving money from one component of M2 to another. This will cause an increase in M1 since checking accounts are part of M1, and a decrease in the savings account component of M2. However, the overall amount of M2 remains unchanged as the total amount of money hasn't changed, just its allocation within M2 components.

d. Finding $0.25 and depositing it into checking account

When you discover \(0.25 and deposit it into your checking account, this will increase both M1 and M2. The physical currency is part of M1, and when it is deposited into a checking account, it remains in M1. Since M2 includes everything in M1, M2 will also increase by \)0.25.

e. Finding $0.25 and depositing it into savings account

Similar to part d, finding the $0.25 will not affect M1 or M2 until it is deposited. When it is deposited into a savings account, it will cause an increase in M2, as savings accounts are part of M2 but not M1. There is no effect on M1 and an increase in M2.