Money Supply M1 vs M2: Understanding Monetary Aggregates

What Is Money Supply?

Money supply measures the total amount of monetary assets in an economy. The Fed tracks several "M" aggregates.

M1: Narrow Money

Definition (Post-May 2020)

M1 includes the most liquid forms of money:

• Currency in circulation
• Demand deposits
• Other checkable deposits
• NEW: Savings deposits (added May 2020)

FRED Series: M1SL | IQ Score: 95

The 2020 Redefinition

In May 2020, the Fed moved savings deposits from M2 to M1, causing M1 to jump from ~$4T to ~$16T overnight. This wasn't money creation—just reclassification.

Watch out: Historical M1 charts show a discontinuity at May 2020.

M2: Broad Money

Definition

M2 includes M1 plus:

• Small-denomination time deposits (<$100K)
• Retail money market funds

FRED Series: M2SL | IQ Score: 96

Why M2 Matters More Now

After the M1 redefinition, M2 is:

• More comparable historically
• Fed's preferred aggregate
• Better for tracking money creation

M2 Growth and Inflation

The 2020-2022 Case Study

Money growth → Inflation with ~12-18 month lag.

Why This Matters

Quantity theory: MV = PY

• M (money supply) up
• V (velocity) stable
• P (prices) must rise or Y (output) increases

Velocity of Money

The Missing Piece

Money velocity = GDP ÷ Money supply

FRED Series: M2V | IQ Score: 93

Velocity Collapse

M2 velocity has been declining for decades:

• 1997 peak: 2.2
• 2020 trough: 1.1
• Why? More money sitting idle, financial innovation

Implications

Low velocity means more money needed for same GDP. Makes money supply signals less reliable.

International Money Supply

ECB Money Supply

• M1: Currency + overnight deposits
• M3: Preferred aggregate (includes repos, money market funds)
• IQ Score: 92

Bank of Japan

• M2: Currency + demand deposits + CDs
• M3: Adds postal savings
• Massive growth during QQE

China (PBoC)

• M2: Very broad definition
• Double-digit growth for decades
• Credit impulse important

How to Analyze Money Supply

Step 1: Track YoY Growth

Monthly levels are noisy. YoY changes show the trend.

Step 2: Compare to Nominal GDP

M2 should grow roughly with nominal GDP over time.

Step 3: Watch for Extremes

• >20% YoY growth = inflation risk ahead
• Negative YoY = unusual, watch for deflation

Step 4: Consider Velocity

Rising velocity can offset slower money growth (and vice versa).

Discontinued Aggregates

M3 (Discontinued 2006)

Included M2 plus large time deposits, institutional money funds. Fed stopped publishing citing low usefulness.

MZM (Money Zero Maturity)

M2 minus time deposits plus institutional money funds. Still published:

FRED Series: MZMSL

Practical Applications

Inflation Forecasting

Watch M2 YoY growth 12-18 months ahead for inflation signals.

Asset Allocation

Money supply surges often correlate with risk asset rallies.

Fed Policy Analysis

QE directly increases money supply. Track for policy effects.

All monetary aggregates with IQ scores available on DataSetIQ for instant comparison.