Course: AP®︎/College Macroeconomics > Unit 4Lesson 3: Definition, measurement, and functions of money
Money supply: M0, M1, and M2
Learn ways to measure the amount of money in circulation. We'll start by looking at "base money" (M0), which refers to physical currency created by the central bank. Then, we'll move on to broader definitions, such as M1 (which includes currency in circulation plus checkable deposits) and M2 (which includes M1 plus savings accounts and other easily convertible assets). Created by Sal Khan.
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- Wouldn't the central bank give it's money to more than one bank? Doesn't it print very large amounts of money?(15 votes)
- Yes, it would: central banks work on a vast scale, and they would buy the securities from a multitude of sources. Sal just simplified the process for ease of explanation.(70 votes)
- At6:29I don't understand why should we define M1 other than for pure theory because "M1 can't happen", I mean for the first person to write a 3$ check, the second wouldn't be able to write a 2$ check simultaneously, isn't it? Because around7:58Sal says that M1 comprises what money can be used (through checks or pocket money) but it would not be possible to use it all at the same time, right? Thank you(20 votes)
- This scenario is a very small scale. You are correct, if person 1 and person 2 tried to take all of their money out of the bank at the same time this would be a run on the bank and the banks would have insufficient funds to complete these transactions (in the US the FDIC would cover the funds).
In the real world banks have 1000s of accounts with 1000s of dollars each. The likelihood of a person or persons trying to withdraw more money than the bank can payout is very low. The likelihood increases as the reserve requirement decreases because the banks have less money in their vaults.(19 votes)
- To what extent are the loans issued by banks to consumers part of the money supply? If a bank allows people to put more on their credit cards every month, and then roll over the payments, does that increase the money supply? Thanks for your help.(12 votes)
- When you spend money on a CC, the MB remains the same and the M1 increases by the amount spent. When the CC is paid off, the MB is still the same and the M1 decreases by the amount paid.(0 votes)
- Is it not true that If i were to deposit $10,000 in my bank account, the bank could loan out 90%. But still have the whole $10,000? In other words, Just create $9,000 dollars out of thin air? And then that $9,000 goes to another bank and the same thing happens and so on... Bank after bank, until the original deposit of $10,000 has magically turned into $90,000.(4 votes)
- Your bank no longer as $10,000; they have $1000 (which is the reserve). They have then loaned the other $9000 out to someone else. You are right there is now $90,000 about but this is not wealth, it is money because there are liabilities at each transaction step.
The reason this works for the bank is they have many, many customers and not every customer is going to walk in on Monday and withdraw all their funds. The banks have historic records of what cash they need to hold to satisfy normal withdrawals. The system of fractional banking does collapse if there is a run on the banks.(6 votes)
- Is there such thing as a global multiplier effect? I know that the US multiplier is typically around 2. Thanks!(6 votes)
- There is a global multiplier, but it is more of an average multiplier that includes all the different currency's multipliers. However, in the modern economy the USD is used almost exclusively for international trade.(2 votes)
- Is it bad if a country has a realy high m2 relative to its m1? Can these two measurements say anything about the strength and stability of the banking industry of a country?(7 votes)
- I don't see how the Money supply would reflect the stability of the banking industry. It does speak of the strength though. It reflects the influence of the banking system in the money supply in turn the economy.
In my opinion, its dangerous because the failure of any of the banking institutions can put the tax payers money more at risk. I can't of think any plus sides for a large M2. Besides the fact that any growth in the money supply may lead to growth (or inflation).
My opinion is skewed towards anti-banking regulations but I think it is relatively more dangerous.(0 votes)
- Could anyone provide anymore insight as to why the Fed stopped reporting M3? I've read their press release where they stated a cost-benefit analysis claimed it was useless, but I don't know if that argument held much water.(5 votes)
- First, M1 & M2 have always been the two most important measures of money. In fact, a lot of Economic textbooks don't even bother with the broader definitions of money (beyond merely acknowledging that broader measures exist, at least). In fact, if you ask an Economics professor, they'd probably be surprised that the Fed had continued publishing data on M3 for as long as they did. So yeah, definitely trust the Fed--they are way more reliable than politicians and pundits.(3 votes)
- 09:27- when Sal counts the 2 dollars from saving accounts, isn´t he double counting? That last person took the money to his her wallet.(3 votes)
- Just to restate what joshkarn said, even though P1 and P2 have each lent out $1, they still physically have those $2 in their respective savings accounts. Is that accurate? Thanks!(1 vote)
- He says M0 is the Monetary Base, but according to Wikipedia, M0 is slightly different from the Monetary Base. But then again, the description of M0 on Wiki also calls it the Monetary Base... I'm starting to think people in Economics don't even know what the real Monetary Base is...(2 votes)
- M0 is not the monetary base (sometimes abbreviated MB). They measure two separate things, even if they are related. M0 refers to the most liquid form of money: cash. That includes central bank notes and coins.
MB refers to the base money supply from which banks can extend the money supply. In addition to M0, that also includes central bank deposits, which can't be used to pay anyone other than banks. They would have to be converted into notes or coins.
The reason why Sal didn't want to talk about the differences is because he didn't want to make things needlessly complicated in talking about central bank deposits. For most purposes, you can consider MB to be M0, but it is important to note that that is not actually the case.(3 votes)
- Is there someplace online that shows a country's past and present M0 vs M1 vs M2 (especially the U.S.)? And does our government use the same names for the different ways to count money as Sal does in the video?(3 votes)
- i think they do(at least for canadian gov. for US i'm not 100% sure. if you go on statisticscanada, you'll be able to find the same M1 & M2 values being used)(1 vote)
What I want to explore in this video is the different ways of measuring the amount of money we have in circulation. So we're going to start things with our Central Bank in the US. This would be the US Federal Reserve. And let's say that they print $4. And we're going to focus, just for visualization purposes, on that they're doing it physically. They could also do it electronically. But we're just going to focus on the physical. And the way that they get this into circulation is it they'll take these $4 and they'll go buy securities in the open market, normally very safe and very liquid securities. Liquid means it's very easy to buy and sell those securities in large quantities. For example, government treasuries is a liquid security, or liquid asset. PEZ dispensers would not be a liquid asset. If I bought a billion dollars worth of PEZ dispensers it would be very hard for me to sell-- one it would be very hard for me to buy a billion dollars worth. And it would be even probably even harder for me to sell a billion dollars worth in any short or medium timeframe. So the Central Bank goes out, and let's say they go and buy one liquid security for $4. So this is a security right over here. And the person that they bought the security from decides to deposit it in a bank. They could either directly deposit it in a bank or they could use that money that they got from selling their security to buy things, and the person they bought things from could deposit it in a bank. But one way or another we can imagine it all gets deposited in a bank. So this is our private bank. I'll call this private bank number one. So now all of these dollars are transferred to private bank number one. And they are no longer-- the Federal Reserve, or the Central Bank, in the general case, is no longer in possession of them. They've been transferred right over here. And I want to cross these out just so we can keep track of things. Now when they deposit it in private bank number one, they said, well, I need three of these dollars on demand. And I want to write checks against them. So they put three of these dollars in a checking account. There are at three of these dollars a checking account. So checks up too-- so write checks up to $3. And so they can get a little bit more interest, and the bank's willing to give a little bit more interest on a savings account because they don't have to keep the reserves, they put $1 into a savings account. And they cannot write checks against that savings account. Now there are special circumstances now, but for simplicity, let's just say that they cannot write checks. There are some that have restricted check writing and things like that now. So this bank says, OK, well, this dollar, I don't have to even have any reserves against it. I could loan out this dollar. And the person they lend it to, let's say that they immediately go and deposit it into another bank. So they immediately go and deposit this in private bank, I'll call this private bank two. So it's no longer in private bank one. Let me draw a private bank two. Private bank two is a right over here. Private bank number two. And they deposit it into a savings account in private bank number two. And let's say all of this, out of all of this, the bank says, well, this is a demand deposit, I have to keep some reserves. This is a fractional reserve system. But I can lend out, in the US, I could lend out up to 90% of this. And maybe this bank is a little bit more conservative, They only lend out 2/3 of this. So they lend out $2 out of these $3 And let's say the person they let it do also happens to deposit it in private bank number two, just coincidentally. So these two also end up in private bank number two. And so they're no longer in private bank number one, although this person could still write checks up to $3. And now here in private bank number two-- and let's say these are deposited in a checking account. These are deposited right over here in a checking account. Now private bank number two, it can do a couple of things. In this checking account it has to keep some reserves. Let's say it's even more conservative. It only decides to lend out half of this, even though it could lend out 90%. And so it lends out one of these dollars. And the person that they lend it to just takes that dollar and they put it in their wallet. So they just put it in their wallet. And they could also lend out this entire savings. And let's just say that the person that they lend that $1 in savings to also puts it in their wallet. And notice, the original $4 are still there. One, two, three, four. Now, and just to be clear, this person right over here can write checks up to $3 . And this person right over here can write checks-- let me do that same checking account color-- they can write checks up to $2. Now let's think about the different forms of money there are here. Well, we could think of money in a very, very narrow way, which is just what did the Central Bank print, or create electronically as electronic reserves of its member banks? But for simplicity here you can just think about the physical currency that it printed, its base money. And so that, often, is just referred to as base money. And in the US and other countries it's often the same thing as M0. There's slight differences from country to country. And in this example, as soon as they printed it and put it into circulation, that was $4. We had $4 of base money. And that's obvious because as soon as they printed this and they bought the security with it, and it was in circulation, that $4 could be used to buy things. It could be used to facilitate transactions. Now that clearly isn't all of the stuff that can be used as money in this little universe we created. This guy, you have the $4 but these people can also write checks right over here. And so we can have a slightly broader definition of money. And over here, we will call it M1. And here, there's a couple of ways you could think about it. You could think about it as all of the currency that's in people's pockets plus all of the check writing capabilities. So if you view it that way it, would be this $2 plus $5 of check writing capabilities right over here. So you could have $2 of physical currency that's in people's wallets, not in bank reserves, plus the $5 of check writing capability, which would give you $7. Another way you could view it, you could view it as M0 plus checkable deposits. I'll just write checks here, plus-- well I'll write-- checkable deposits. But if you do that, you are now double counting because some of the M0 is reserves in the checkable deposits. Or you could say some of the checkable deposits is held as reserves for M0. So then you would have to subtract out the bank reserves. And so then you would get $4 because we don't want to double count these right over here. You would get M0 is $4. And I want to do that in white. M0 is $4. The checkable deposits is $5. Let me do that in the pink. Plus the $5. And then you would want to subtract out the reserves. And the reserves here, there are $2 of the reserves. So minus $2. And you would get yourself back to the $7. And the whole point of this is so you're not double counting something, you're not double counting this right over here, as part of checkable deposits and part of the M0. You're not using this twice. It's not part of the base money. It is both the base money and checkable deposits. And we don't want to count it twice. So the simplest way to think about is, well, what can be used in this broader definition to facilitate transactions? These $2 in people's pockets, and this ability to write up to $5 of checks. So that's this view right over here. And if we want to get even broader than that, we can get to something called M2. And here we could say, OK, what's immediately usable to facilitate a transaction right now? So that would be our M1. So that would be our $7 of M1. Plus things that can be easily converted to M1. So for example, these savings accounts can be easily converted to checking accounts. It might only take a couple of days. There might be some restrictions. But it can be converted. And when it gets converted will change the bank's reserve requirements a little bit. But it will allow, if this person converts it they will have the ability to write more checks. So M2 includes M1 plus things that are very easy to convert to M1. And so they'll include things like savings accounts, money market accounts, which I won't go into detail here. But they're really kind of similar in that you get slightly higher interest, but there are restrictions on your ability to access it. But it's not too hard to turn it into checking accounts. And small dollar value time deposit, CD accounts. But for the sake of simplicity, in this example, it would be the saving accounts. So it would be our $7 of M1, plus the $2 of savings accounts right over here. So this is just to give you a picture. When someone talks about the money supply you really have to say, well, what are you talking about? The most typical one is that you're really talking about M1, because this is the stuff that's directly usable to facilitate transactions. Things like the ability to write a check, or dollar bills in someone's wallet. But they might be talking about base money, M0, narrow money, always of referring to the same thing, especially in the United States. Or they might be referring to something even broader. And there are broader definitions even than M2, although M3, they've stopped reporting about it. But M3 would have things that are a little bit further from being true money, from being a checking account. But they are already fairly liquid and so they'll include other types of assets. But the Fed has stopped reporting this in the recent past. So these are the ones that are typically referred to.