7.4.1. Money Supply and Monetary Aggregates
Because interest rates are a price—the price of using someone else’s money—they are affected by the laws of supply and demand in ways that are probably familiar to you. Changes in the money supply put pressure on interest rates to change in the opposite direction: downward pressure if there’s more money available for lending, upward pressure if there’s less. The money supply is simply the number of dollars available in the whole economy. When it comes to determining the size of the money supply, a lot depends on how strictly you define “available.” In the U.S., there are three primary monetary aggregates, or ways of measuring the money supply. There are many others, but these are the ones you should focus on for the exam.
M1 is the narrowest and most liquid of the major monetary aggregates. M1 includes physical money (notes and coins in circulation) as well as funds that can be spent immediately, such as checking and other accounts against which checks can be written (called demand deposits). M1 also includes traveler’s checks.
M2 includes M1 and adds other monies that cannot be spent on demand, such as savings accounts, short-term money market accounts, and time deposits (CDs) of less than $100,000. M2 is much larger than M1.
M3 adds longer term time deposits, repurchase agreements, and institutional money market accounts to M2. The Federal Reserve Bank publishes M1 and M2 figu