Question

Assume that you are interested in earning some return on the idle balances you usually keep in your checking account and decide to buy some money market mutual funds shares by writing a check. Comment on the effect of your action (with everything else the same) on M1 and M2

Short answer

When mutual fund share is purchase via check the M1 will decrease and M2 will increase.

Step-by-step solution

Step 1.  Introduction

In money market there are 4 measures of money supply in the economy they are M1, M2, M3, and M4. Where M1 and M2 are narrow money. Currency and money in checking accounts are included in M1 (demand deposits). M1 also includes traveler's checks, but they are becoming less popular. All of M1 is included in M2, as well as savings deposits, time deposits such as certificates of deposit, and money market funds.

Step 2. Explanation

In a situation when someone buys some money market mutual funds shares by writing a check in such a case M1 will decrease and M2 will increase as mutual fund share will directly effect the M2 supply of money. As a result initially M1 will increase by the return and affect M2 after purchasing mutual fund share by writing a check the M1 will decrease and M2 will increase.