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### Course: AP®︎/College Macroeconomics>Unit 4

Lesson 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.

## Want to join the conversation?

• Wouldn't the central bank give it's money to more than one bank? Doesn't it print very large amounts of money?
• 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.
• At I 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 around Sal 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
• 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.
• 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.
• 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.
• 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.
• 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.
• Is there such thing as a global multiplier effect? I know that the US multiplier is typically around 2. Thanks!
• 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.
• 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?
• 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.
• 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.
• 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.
• 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...
• 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.