Measuring the Money Supply
Households, firms, and policymakers are all interested in measuring money because, as we will see, changes in the quantity of money are associated with changes in interest rates, prices, production, and employment. Recall that one of the functions that money provides is to serve as a medium of exchange. If this were the only function of money, then money should include only currency, checking account deposits, and traveler’s checks because households and firms can easily use these assets to buy goodsand services.
Households, firms, and policymakers are all interested in measuring money because, as we will see, changes in the quantity of money are associated with changes in interest rates, prices, production, and employment. Recall that one of the functions that money provides is to serve as a medium of exchange. If this were the only function of money, then money should include only currency, checking account deposits, and traveler’s checks because households and firms can easily use these assets to buy goodsand services.
But including just these three assets would result in too narrow a measure of the money supply in the real world. Many other assets can be used as a medium of exchange, even though they are not as liquid as cash or a checking account deposit. For example, you can easily convert your savings account at a bank into cash. Likewise, if you own shares in a money market mutual fund which is a mutual fund that invests exclusively in short-term bonds, such as Treasury bills you can write checks against the value of your shares. So, assets such as savings accounts and money market mutual fund shares can plausibly be considered part of the medium of exchange
Measuring Monetary Aggregates
As part of its responsibility to regulate the quantity of money in the United States, the Federal Reserve currently publishes data on two different definitions of the money supply. Figure 2.1 illustrates these definitions referred to as monetary aggregates graphically
Measuring Monetary Aggregates
As part of its responsibility to regulate the quantity of money in the United States, the Federal Reserve currently publishes data on two different definitions of the money supply. Figure 2.1 illustrates these definitions referred to as monetary aggregates graphically
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M1 Aggregate The narrower definition of the money supply is M1. As panel (a) in Figure 2.1 shows, M1 measures money as the traditional medium of exchange: currency, checking account deposits, and traveler’s checks. Through the early 1980s, government regulations did not allow banks to pay interest on checking accounts, which made them close substitutes for currency. Since then, financial innovation in the banking industry and government deregulation in the 1970s, 1980s, and 1990s have made more types of accounts close substitutes for traditional bank checking accounts. These new accounts include checking accounts at savings institutions and credit unions, as well as interest-bearing checking accounts at commercial banks.Measures of M1 now include these other deposits against which checks may be written, along with non-interestbearing checking account deposits called demand deposits, traveler’s checks, and currency.
M2 Aggregate M2 is a broader measure of the money supply than M1 and includes accounts that many households treat as short-term investments. These accounts can be converted into currency, although not as easily as the components of M1. As shown in panel (b) of Figure 2.1, in addition to the assets included in M1, M2 includes:
● Time deposits with a value of less than $100,000, primarily certificates of deposits in banks.
● Savings accounts.
● Money market deposit accounts at banks.
● Noninstitutional money market mutual fund shares. “Noninstitutional” means
that the money market fund shares are owned by individual investors rather than by institutional investors, such as pension funds. Noninstitutional is also sometimes referred to as “retail.”
M2 Aggregate M2 is a broader measure of the money supply than M1 and includes accounts that many households treat as short-term investments. These accounts can be converted into currency, although not as easily as the components of M1. As shown in panel (b) of Figure 2.1, in addition to the assets included in M1, M2 includes:
● Time deposits with a value of less than $100,000, primarily certificates of deposits in banks.
● Savings accounts.
● Money market deposit accounts at banks.
● Noninstitutional money market mutual fund shares. “Noninstitutional” means
that the money market fund shares are owned by individual investors rather than by institutional investors, such as pension funds. Noninstitutional is also sometimes referred to as “retail.”
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