M2 is a measure of the money supply that encompasses cash, checking deposits, small-denomination time deposits, and balances in retail money market funds. It is a broader measure of the money supply than M1, which only includes cash and checking deposits. M2 is calculated by adding M1 to the sum of small-denomination time deposits and retail money market funds, excluding individual retirement account (IRA) and Keogh balances.
Key Facts
- M2 includes M1, which consists of currency in circulation and demand deposits (checking accounts) held by individuals and businesses.
- Small-denomination time deposits (time deposits in amounts of less than $100,000) are also included in M2. These are time deposits held at depository institutions, excluding individual retirement account (IRA) and Keogh balances.
- Balances in retail money market funds (MMFs) are part of M2. However, IRA and Keogh balances at MMFs are excluded.
Important Facts:
- M2 is a measure of the money supply that includes cash, checking deposits, small-denomination time deposits, and balances in retail money market funds.
- M2 is a broader measure than M1, which only includes cash and checking deposits.
- The Federal Reserve releases M1 and M2 numbers on a regular basis, and economists often use the broader M2 number when discussing the money supply.
- M2 is a critical factor in forecasting inflation and is closely monitored for signs of inflationary pressures.
- M2 is not a leading economic indicator, but it is seen as a reliable predictor of inflation.
Components of M2
-
Currency in Circulation
This includes Federal Reserve notes and coins held by individuals and businesses outside of the U.S. Treasury, Federal Reserve Banks, and depository institution vaults.
-
Demand Deposits
These are checking accounts held by individuals and businesses at depository institutions, excluding amounts held by depository institutions themselves, the U.S. government, and foreign banks and official institutions.
-
Small-Denomination Time Deposits
These are time deposits with an original maturity of less than $100,000 held at depository institutions, excluding IRA and Keogh balances.
-
Retail Money Market Funds
These are money market funds that are available to individual investors. IRA and Keogh balances in money market funds are excluded.
Significance of M2
M2 is a critical factor in forecasting inflation. A significant increase in M2 can be a warning sign of potential inflationary pressures. The Federal Reserve closely monitors M2 to assess the overall health of the economy and make appropriate monetary policy decisions.
M2 is also seen as a reliable predictor of inflation, although it is not a leading economic indicator. Economists often use M2 when discussing the money supply and its impact on the economy.
Conclusion
M2 is a comprehensive measure of the money supply that includes cash, checking deposits, small-denomination time deposits, and balances in retail money market funds. It is a broader measure than M1 and is closely monitored by the Federal Reserve as a key indicator of inflation and overall economic health.
Sources
- Board of Governors of the Federal Reserve System. (2023, December 26). Money Stock Measures – H.6 Release. https://www.federalreserve.gov/releases/h6/current/default.htm
- Federal Reserve Bank of St. Louis. (n.d.). M2 and Components. https://fred.stlouisfed.org/categories/29
- The Investopedia Team. (2023, May 27). M2 Definition and Meaning in the Money Supply. Investopedia. https://www.investopedia.com/terms/m/m2.asp
FAQs
What is M2?
M2 is a measure of the money supply that includes cash, checking deposits, small-denomination time deposits, and balances in retail money market funds. It is a broader measure of the money supply than M1, which only includes cash and checking deposits.
What are the components of M2?
The components of M2 are:
- Currency in circulation
- Demand deposits
- Small-denomination time deposits (less than $100,000)
- Balances in retail money market funds (excluding IRA and Keogh balances)
Why is M2 important?
M2 is important because it is a key indicator of inflation and overall economic health. A significant increase in M2 can be a warning sign of potential inflationary pressures. The Federal Reserve closely monitors M2 to assess the overall health of the economy and make appropriate monetary policy decisions.
How is M2 calculated?
M2 is calculated by adding M1 to the sum of small-denomination time deposits and retail money market funds, excluding IRA and Keogh balances.
What is the difference between M1 and M2?
M2 is a broader measure of the money supply than M1. M1 only includes cash and checking deposits, while M2 includes M1 plus small-denomination time deposits and balances in retail money market funds.
How often is M2 released?
M2 is released on a regular basis by the Federal Reserve. The exact frequency may vary, but it is typically released monthly or weekly.
Who uses M2?
M2 is used by economists, policymakers, and financial analysts to assess the overall health of the economy and make informed decisions.
Is M2 a perfect measure of the money supply?
No, M2 is not a perfect measure of the money supply. It does not include all types of liquid assets, such as large-denomination time deposits and institutional money market funds. However, M2 is a widely accepted and useful measure of the money supply.