5.5: Measures of Money II

M2 is a commonly used measure of an economy’s money supply. It is used in several countries, such as Canada and the United States, although the specific components included can differ from one country to another.

In the United States, M2 includes all the components of M1, as well as a few other components. M1 consists of currency, demand deposits, and other liquid deposits. M2 includes M1, small-denomination time deposits, and retail money market mutual fund shares.

Time deposits are a type of savings instrument in which the money is payable to the depositor on a specific date known as the maturity date. Early withdrawals incur a penalty. Deposits of less than $100,000 are considered small-denomination time deposits. M2 includes small-denomination time deposits.

Retail money market mutual fund shares are another component of M2. These are offered to individual investors and managed by investment companies. The funds invest in short-term, low-risk financial instruments, and investors can redeem their shares on demand.

As M2 includes M1 along with small-denomination time deposits and retail money market mutual fund shares, it provides a broader view of the money available in the economy. The quantity of M1 is also added to the quantities of less liquid categories of the money supply, because the total money supply is a key determinant of inflation, interest rates, and the overall economic health of the nation’s economy.

M2 is one way to measure an economy's money supply. It is used in many countries, including Canada and the United States. What M2 includes may vary across countries. Consider the U.S., where the Fed measures the money supply and categorizes it according to the liquidity of each type of money. M1 includes the most liquid assets that can be spent immediately.

There are other categories of money that are less liquid because they take more time to access and become liquid. These types of money are added to M1 to form the category of the money supply known as M2. M2 includes M1 and adds small-denomination time deposits and retail money market mutual fund shares.

Time deposits are a type of savings instrument. The money is payable to the depositor on a specified date called the maturity date. Early withdrawals incur a penalty. Small-denomination time deposits are those issued in amounts of less than $100,000.

Retail money market mutual fund shares, or retail MMFs, are available to individual investors through investment companies like Vanguard. They are redeemable on demand, meaning investors can sell their shares back to the investment company.