Learn all about the supply of money in just a few minutes! Professor Jadrian Wooten of Penn State University explains how the Federal Reserve uses M1 and M2 definitions of the money supply to measure the amount of money in the economy.
The supply of money is determined by a country's central banking institution, which is the Federal Reserve System in the United States.
The Federal Reserve (Fed) is the central bank of the United States. A central bank provides financial and banking services for its country's government and commercial banking system, implements monetary policy (intervention in the economy through central bank actions, such as adjustments to interest rates, reserve requirements, and open market operations, that affect the money supply and interest rates), and issues currency. One of the central bank's most important roles is to manage the economy so that there is full employment and stable prices. One of the tools the Fed uses to achieve these goals is determining the amount of money in the economy. Therefore, the supply of money, the quantity of money available in the economy, is set by the Fed, independent of the interest rate. This makes the supply of money a vertical line at whatever quantity of money the Fed determines based on monetary policy and price levels.
The Fed uses two definitions of the money supply to measure the amount of money in the economy. M1 contains the most liquid forms of monetary assets: currency, checkable deposits, and travelers' checks. These are the forms of money that are most often used as a medium of exchange. Most stores take any of these three methods for payment for goods and services. In September 2017, the Federal Reserve estimated the value of M1 to be $3,550.6 billion.
The definition of M2 is much broader; it includes everything in M1 along with savings deposits, money market mutual funds, and certificates of deposit less than $100,000. These accounts are less liquid than the assets in M1 but can still be used relatively easily if needed. All an individual has to do is transfer her savings deposit to her checking deposit or withdraw funds using an automated teller machine (ATM) to make a purchase. However, an individual cannot use her savings account directly to purchase something in a store without taking those additional steps to move the money into a more liquid form. The Federal Reserve estimated that the value of M2 was $13,701.2 billion in September 2017. Thus, individuals hold a great portion of their money in less-liquid forms such as savings accounts and small deposits.
It is important to realize that money represents more than just currency. Money is currency and deposits that an individual can access very easily. In fact, in September 2017, only $1,503.9 billion of currency was in the hands of the public. By far, the majority of money in the U.S. economy is in deposits at banks or is reflected in the M2 monetary supply. It is not printed currency but rather longer-term assets that are less liquid.
Another important thing to note is that credit cards have not been mentioned. Although a person can use a credit card to buy a good or service, he is not paying for the product at that time. Rather, he is deferring payment to a later date. In other words, a credit card is not a store of value. Therefore, credit cards are not considered a form of money in the economy. In contrast, a debit card is directly linked to an individual's checkable deposits and thus the store of value function of money.