Key Takeaways
- M2 includes M1 plus savings and small time deposits.
- Broad money measure tracking liquid assets beyond cash.
- Central banks adjust M2 to influence inflation and growth.
- M2 redefined in 2020, shifting savings accounts to M1.
What is M2?
M2 is a broad measure of the money supply that includes M1—currency and checkable deposits—plus additional liquid assets like savings deposits, small time deposits, and retail money market mutual funds. It provides a wider view of the available money in the economy than M1 alone.
This aggregate is essential for understanding monetary policy impacts and inflation trends.
Key Characteristics
M2 captures several types of liquid assets beyond immediate cash, making it a key economic indicator.
- Inclusion of M1: Currency in circulation and demand deposits form the base of M2.
- Savings deposits: Unlike M1, M2 includes savings accounts, which are less liquid but still readily accessible.
- Small time deposits: Certificates of deposit under $100,000 contribute to M2's breadth.
- Retail money market funds: Shares in these funds add another liquid asset class to M2.
- Broad liquidity: M2 encompasses assets that can be quickly converted to cash, impacting consumer spending and investment.
How It Works
Central banks influence M2 through policies such as open market operations, adjusting the money supply to stabilize the economy. By buying or selling government securities, they can increase or decrease the liquid assets counted in M2.
Changes in interest rates also affect M2; lower rates encourage borrowing and increase money supply, while higher rates have the opposite effect. Understanding M2 helps you gauge monetary policy’s impact on inflation and economic growth, as reflected in concepts like the Phillips curve.
Examples and Use Cases
M2 data is leveraged by investors and policymakers to assess economic conditions and make informed decisions.
- Banking sector: When evaluating bank stocks, consider how changes in M2 affect lending capacity and liquidity.
- Bond markets: Fluctuations in M2 influence demand for fixed income assets, relevant when selecting from bond ETFs.
- Index funds: Economic trends indicated by M2 can impact broad market indices, guiding choices in low-cost index funds.
Important Considerations
M2's composition and measurement can shift over time; for example, recent changes moved certain savings accounts between M1 and M2 categories. Always consider these nuances when analyzing monetary supply data.
While M2 is a valuable economic gauge, it works best in conjunction with other indicators, like leverage levels and macroeconomic trends, to form a comprehensive understanding of financial conditions.
Final Words
M2 offers a broader view of money supply by including liquid assets beyond cash, making it a key indicator for inflation trends with a notable lag. Monitor central bank policies and M2 shifts to anticipate economic changes that may impact your financial decisions.
Frequently Asked Questions
M2 is a broad measure of the money supply that includes M1 components like currency and checkable deposits, plus additional liquid assets such as small time deposits and retail money market mutual funds.
M2 includes everything in M1, which is mainly cash and checking deposits, but also adds savings deposits, small time deposits, and money market funds, making it a more comprehensive indicator of money available in the economy.
M2 is important because it reflects a broader set of liquid assets that can influence spending and inflation. An increase in M2 can lead to inflation if economic output stays the same, though the effects typically show up after 12 to 18 months.
Central banks affect M2 through tools like quantitative easing, bond issuance, and adjusting interest rates, which can either increase or decrease the amount of money circulating in the economy.
M2 includes currency in circulation, checkable deposits, savings deposits, small-denomination time deposits under $100,000, and retail money market mutual fund shares.
Yes, since May 2020, the Federal Reserve redefined M2 by moving savings accounts from M2 into M1, reflecting changes in how people use deposit accounts, so now M2 is calculated as M1 plus time deposits, certificates of deposit, and money market funds.
Small time deposits are fixed-term deposits under $100,000 included in M2, representing funds that are less liquid than cash but still accessible, contributing to the broader money supply measurement.
