M1 and M2

This strange stuff called money is managed and measured by the Federal Reserve in the United States. There are two primary measures that the Fed uses when describing the money supply, M1 and M2. The M1 is composed of all of the checking account balances, cash, coins, and traveler's checks circulating in the economy. The M2 is composed of everything in the M1 plus all savings account balances, certificates of deposit, money market account balances, and U.S. dollars on deposit in foreign banks. The M1 is mainly used as a medium of exchange, whereas the M2 is used as a store of value. The M2 is larger and less liquid than the M1.

The currency and coin inside of a bank is not counted in the M1. Why not? Because it's not money until you walk out of the bank. So technically, it is inaccurate for a bank robber to demand money while in a bank.

Changes in the M1 and M2 are monitored by the Fed and act as indicators of economic activity. Sudden changes in the ratio of M1 to M2 might indicate either imminent inflation or recession. In general, if the M1 grows faster than the combined rate of labor force and productivity growth, then inflation will result. If, however, the M2 were to suddenly grow at the expense of M1 because people are saving and not spending, then that would tend to indicate that the economy is headed toward recession.

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