Q.
Differentiate between M1 and M2 supply of money. (4 marks)
(4 marks, 2012 Q7c)
A.
This definition of M1, M2 or even M0, MB, M3 and M4 are different measures of money supply.
- M0 and M1, also called narrow money, normally include coins and notes in circulation and other money equivalents that are easily convertible into cash.
- M2 includes M1 plus short-term time deposits in banks and 24-hour money market funds.
- M3 includes M2 plus longer-term time deposits and money market funds with more than 24-hour maturity. The exact definitions of the three measures depend on the country.
- M4 includes M3 plus other deposits.
Another good explanation is from Federal Reserve (FRB).
The money supply is commonly defined to be a group of safe assets that households and businesses can use to make payments or to hold as short-term investments. For example, U.S. currency and balances held in checking accounts and savings accounts are included in many measures of the money supply.
There are several standard measures of the money supply, including the monetary base, M1, and M2. The monetary base is defined as the sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve). M1 is defined as the sum of currency held by the public and transaction deposits at depository institutions (which are financial institutions that obtain their funds mainly through deposits from the public, such as commercial banks, savings and loan associations, savings banks, and credit unions). M2 is defined as M1 plus savings deposits, small-denomination time deposits (those issued in amounts of less than $100,000), and retail money market mutual fund shares. Data on monetary aggregates are reported in the Federal Reserve's H.3 statistical release ("Aggregate Reserves of Depository Institutions and the Monetary Base") and H.6 statistical release ("Money Stock Measures").
Over some periods, measures of the money supply have exhibited fairly close relationships with important economic variables such as nominal gross domestic product (GDP) and the price level. Based partly on these relationships, some economists--Milton Friedman being the most famous example--have argued that the money supply provides important information about the near-term course for the economy and determines the level of prices and inflation in the long run. Central banks, including the Federal Reserve, have at times used measures of the money supply as an important guide in the conduct of monetary policy.
Over recent decades, however, the relationships between various measures of the money supply and variables such as GDP growth and inflation in the United States have been quite unstable. As a result, the importance of the money supply as a guide for the conduct of monetary policy in the United States has diminished over time. The Federal Open Market Committee, the monetary policymaking body of the Federal Reserve System, still regularly reviews money supply data in conducting monetary policy, but money supply figures are just part of a wide array of financial and economic data that policymakers review.