Question

Which of the following is part of the M2 definition of the money supply, but not part of M1? a. Checkable Deposits b. Currency held in banks c. Currency in circulation d. Money market mutual fund shares

Short answer

The correct answer is option D: Money market mutual fund shares, as they are part of the M2 money supply but not the M1 money supply.

Step-by-step solution

Option A: Checkable Deposits

Checkable deposits are the accounts in which you may write checks payable on demand. These deposits are a part of both M1 and M2 definitions, as they are considered a liquid form of money. So option A is not the correct answer.

Option B: Currency held in banks

Currency held in banks is the amount of cash kept in the banks' vaults. This currency is not in circulation, so it is not considered a part of either M1 or M2 money supply. Therefore, option B is not the correct answer.

Option C: Currency in circulation

Currency in circulation refers to all physical currency - i.e., banknotes and coins - that is out and not held in banks' vaults. This is considered a very liquid form of money and is included in both M1 and M2 definitions. So option C is not the correct answer.

Option D: Money market mutual fund shares

Money market mutual fund shares represent investments in short-term debt securities and are considered less Liquid compared to other components in the M1 definition. They are part of the M2 money supply but not the M1 money supply, and therefore, option D should be the correct answer. So, the correct answer to this question is: Option D: Money market mutual fund shares.

Key concepts

M1

M1 is the most liquid portion of the money supply in an economy. It includes financial assets that can be quickly and easily converted into cash to purchase goods and services. Components of M1 are:

• Currency in circulation: This includes all paper money and coins held by the public, excluding those in banks.
• Checkable deposits: These are bank accounts that allow the holder to write checks or use debit cards for payment, such as standard checking accounts.
• Traveler's checks: These are pre-printed checks that were widely used by travelers but are now less common due to digital banking.

M1 reflects the money supply that is readily accessible for transactions and is used in day-to-day purchases. It is a crucial measure since it shows the amount of money available in the economy for spending.

M2

M2 is a broader measure of the money supply compared to M1. It encompasses all elements of M1 plus additional components that are slightly less liquid. M2 includes:

• All of M1: This ensures that M2 encompasses the most easily convertible forms of money.
• Savings deposits: These are accounts where money can earn interest, but withdrawals are less frequent, such as savings accounts.
• Small time deposits: Also known as certificates of deposit (CDs), which are fixed-term investments in banks.
• Money market deposit accounts: Interest-bearing accounts with features similar to checking accounts but with limited transactions.
• Money market mutual fund shares: Investment funds that pool money to purchase short-term, low-risk securities, included in M2 but not liquid enough for inclusion in M1.

M2 captures how easily money can influence an economy's buying power. It gives a more comprehensive look at the money accessible for investment and spending.

Money Market Mutual Funds

Money market mutual funds are investment vehicles that pool money from multiple investors to purchase short-term, low-risk securities, such as Treasury bills and commercial paper. These funds are managed to ensure liquidity, safety, and return on investment. Here are some key features:

• Short-term Investments: They invest in securities that mature in a short period, often less than a year, to reduce risk and maintain liquidity.
• Low-Risk: They are considered low-risk investments because they mostly invest in high-quality, government-backed securities.
• Higher Returns: They typically offer higher returns compared to standard savings accounts but do not provide the high liquidity of checking accounts.

These funds are included in M2, not M1, because they are not as liquid as cash or checkable deposits but still represent a significant portion of money accessible for spending after a brief delay. They provide a balance between risk and return and are a popular choice for investors seeking slightly higher yields on their money.