Money supply measures can be categorized into three types. They are M1, M2 and M3. These measures are based on the degrees of liquidity.
M2 money supply consists of the following things:
- Savings deposits, which include money, market deposit accounts.
- Time deposits of small denominations, that is, time deposits that are of amounts less than $ 100,000. From this, individual retirement account (IRA) and Keogh balances at depository institutions are deducted.
- Balances in retail money market mutual funds from which IRA and Keogh balances at money market mutual funds are deducted.
M2 money supplies are seasonally adjusted by adding small denomination time deposits, savings deposits and retail money funds. All these are adjusted separately and this result is summed up with seasonally adjusted M1. M2 includes savings and small time deposits, overnight repos of commercial banks and non-institutional money market accounts. According to the Federal Reserve Bank of New York, M2 was approximately $ 6.8 trillion and this amount largely consisted of savings deposits.
Broadly speaking,
M2 money supply is a measure of total money supply. All the factors of M1 money supply are included in M2 and with these are added savings and other time deposits. M2 is the next level of liquidity of M1.M1 takes into its purview it includes currency in the hands of individuals, travelers checks, demand deposits and other deposits against which a check can be written, tenders held outside banks, checking accounts minus the amount of money in the federal reserves float, Negotiable Order of Withdrawal (NOW) accounts, Super NOW accounts, Automatic Transfer Services (ATS) accounts and credit union share drafts. Precisely, it includes all the currency in circulation, all paper money and minted coins.
It was in 1990s that the relationship between the performance of the economy and growth of M2 money supply became less significant. The interest rates recorded had reached an all time low in 30 years. This prompted many investors to move the funds they had in savings and time deposits that were part of M2 into bond mutual funds and stocks that are not included in the three money supply measures. If the relation between M2 and nominal income had remained as before, then the behavior of M2 would have been consistent with an economy in extreme contraction. In spite of all the limitations M2 is still considered to be the most important indicator of the financial conditions in an economy. The concept of M2 is broader than that of M1.