In the following guide we will talk about M2 money supply as it is an important measure of the amount of money available for spending and investing in the economy.
Economists use liquidity as the basis for a broader definition of money, rather than relying on a single measurement. Liquidity is determined by how easily a financial asset can be converted into cash for the purpose of purchasing goods or services. While cash is highly liquid, other forms of payment such as checks or credit cards may be less liquid. For example, $10 in cash can easily be used to buy lunch, while the same amount in a savings account would require a trip to the bank or an ATM to withdraw the money, making it less liquid.
This brings us to the discussion of measuring the broader form of money. In particular, we will talk about the money supply M2. Basically, the M2 money supply is a broader measure of the money supply that includes components beyond the most liquid forms of money. M2 includes savings deposits, time deposits and money market funds.
In particular, the concept of liquidity is important to define what constitutes money in M2. Liquidity refers to how quickly a financial asset can be used to purchase a good or service. While cash is highly liquid, financial assets held in savings accounts or other less liquid forms are not as easy to use. These less liquid forms of money are still considered part of the broader M2 money supply, but are not as easily accessible as cash.
money supply defined
Money supply refers to the total amount of money circulating in a country’s economy at any given time. It includes all forms of money, such as cash, bank deposits, and other financial assets that can be used as a medium of exchange.
The amount of money can be measured in a number of ways, including M1, M2, and M3, which represent different types of money and financial assets included in the total measurement.
In addition, changes in the money supply can have significant effects on the economy, including inflation or deflation, interest rates, and economic growth. Therefore, monitoring and managing the money supply is an important task for central banks and governments.
M2 money supply explained
As already mentioned, the money supply M2 is a measure of the total amount of money circulating in an economy. It is broader than M1, which includes only the most liquid forms of money.
It works by providing a broader measure of the amount of money available in an economy that can be used to support economic activity. The M2 money supply is only useful for monetary authorities, business owners and individuals.
Basically, individuals and businesses can monitor the M2 money supply to understand broader economic trends and make informed financial decisions. For example, changes in the money supply M2 can affect the availability of credit and the cost of credit, which can affect business investment and consumer spending.
Therefore, understanding how the M2 money supply works can help individuals and businesses make strategic financial decisions that support their financial goals.
The components of M2 represent different levels of liquidity, which means that some forms of money are easier to transact with than others. The different components of M2 are typically held by different types of institutions and individuals and may have different interest rates and other characteristics. Below is a brief overview of the components of the money stock M2:
- The M1 money supply includes the most liquid forms of money, such as B. physical currency, current account deposits and travelers checks.
- Savings deposits include savings accounts, money market accounts, and certificates of deposit (CDs). These are less liquid than M1 money, but can still be converted into cash relatively quickly.
- Fixed-term deposits include CDs and other fixed-term deposits that are held for a set period of time before being withdrawn. These are less liquid than M1 and savings deposits.
- Retail money market funds are mutual funds that invest in short-term, low-risk securities such as government bonds and certificates of deposit. They are less liquid than M1 and savings deposits, but can still be easily converted into cash.
M2 and inflation
As mentioned earlier, M2 serves as a broader measure of the amount of money in an economy compared to M1, which only considers money held by the public. As a result, M2 has so far proved to be a useful indicator of potential changes in inflation levels.
When the M2 money supply increases, inflation can increase, and when it is constrained by central banks, inflation can decrease. However, inflation typically reacts to the increased money supply with a lag of 12 to 18 months. It is important to note that inflation will only increase if the money supply increases without a corresponding increase in economic output. If economic output increases in line with the money supply, inflation may not increase at all.
Calculate M2
The M2 money supply is calculated by adding up several components representing different types of assets that are commonly accepted as means of payment in the economy. The specific components of M2 may vary slightly depending on the country and the organization measuring it. However, in the United States, the components of M2 are typically currency in circulation, demand deposits, savings deposits, money market deposit accounts, and time deposits.
To calculate M2, simply add the values of these five components. The resulting total represents the amount of money in the economy that is readily available for spending and investing, but excludes assets that are less liquid or not widely accepted as means of payment. It is important to note that the specific components and calculation methods for M2 can vary from country to country and over time, so it is always best to consult reliable sources for the most up-to-date information.
M2 vs. M1 vs. M3
M1 and M2 are the most commonly used measures of money supply, with M1 being the most narrowly defined and M2 being the broader measure, encompassing M1 plus additional types of deposits. M3 is used less frequently because it includes assets that are not as widely accepted as means of payment and may be less relevant for measuring the overall liquidity of the economy.
M1, M2 and M3 are different measures of the amount of money in an economy, with each measure encompassing different types of assets. Let’s take a quick look at the individual measures:
- M1 – the narrowest measure of money supply and includes the most liquid types of money, such as B. physical currency and coins in circulation, as well as check deposits that can be easily converted into cash.
- M2 – a broader measure of money that includes all assets in M1, as well as other types of deposits that are less liquid but are still widely accepted as means of payment, such as B. Savings deposits, money market deposits and small-denomination deposits Time deposits.
- M3 – the most comprehensive measure of money supply and includes all assets in M2 as well as other types of assets that are not as commonly used as means of payment such as other forms of money held by financial institutions.
bottom line
M2 money supply is a broader measure of the money supply in an economy than M1, as it includes all assets in M1 as well as other types of deposits that are less liquid but are still widely accepted as means of payment. M2 is an important indicator for measuring an economy’s overall liquidity, assessing potential inflationary pressures and the impact of monetary policy. Central banks use M2 as a tool to manage the money supply and achieve their economic goals, such as B. Controlling inflation and promoting economic growth. Ultimately, the M2 money supply provides important insight into the health of an economy and is a crucial component of macroeconomic analysis and policy making.
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