Question

What components of money do we count in M2?

Short answer

M2 is a measure of the money supply that includes not just cash and checking deposits (which are part of M1), but also near-money assets that can be quickly converted into cash. The additional components of M2 not included in M1 are savings deposits, money market deposit accounts (MMDAs), small denomination time deposits, and retail money market mutual funds.

Step-by-step solution

Define M2

M2 is a measure of the money supply that includes a broader range of financial assets than M1, another measure of money supply. M2 includes not just cash and checking deposits, but also near-money assets that can be quickly and easily converted into cash.

Explain M1

M1 is a narrow measure of the money supply that includes only the most liquid assets. M1 includes physical currency (paper money and coins), checking account deposits, and traveler's checks. It is important to understand M1 because M2 includes all the components of M1.

Identify components of M2 not included in M1

M2 includes all the components of M1, plus additional financial assets that are relatively easy to convert into cash. These additional components include: 1. Savings deposits: These are accounts at banks and other financial institutions that pay interest and have no fixed maturity date. Depositors can withdraw their money at any time without penalty. 2. Money market deposit accounts (MMDAs): Similar to savings deposits, these accounts pay interest and have no fixed maturity date. However, MMDAs usually require a higher minimum balance and may have more restrictions on the number of withdrawals allowed per month. 3. Small denomination time deposits: These are interest-bearing deposits with a fixed maturity date, usually less than $100,000. Examples include certificates of deposit (CDs) and other short-term investments with a term of less than a year. 4. Retail money market mutual funds: These are investment funds that pool the money of individual investors to purchase short-term, high-quality, and liquid debt instruments, such as U.S. government securities, commercial paper, and bankers' acceptances. Shareholders can typically redeem their shares on demand at the current market value. By summing all these components, we have M2, which provides a more complete picture of the money supply in an economy.