What is M2

In any economic system, the definition of something as seemingly straightforward as “money” can be surprisingly elusive. “Money” likely has very different meanings for an individual investor, a large financial firm, and a central bank or government, for instance. From the perspective of the study of economics, the money supply of a particular economy is equal to the total value of all monetary assets available within that economy. Central banks watch carefully over the money supply of a country to guard against issues like long-term price inflation, which often comes about as a result of rapid growth of the money supply of a country.

Measuring the money supply of an economy is a challenging proposition. Due to the complexity of the concept of “money,” as well as the size and level of detail of an economy, there are multiple ways of measuring a money supply. These means of measuring a money supply are typically classified as “M”s and fall along a spectrum from narrow to broad monetary aggregates. Typically, the “M”s range from M0 to M3, with M2 typically representing a fairly broad measure.

M2 is a calculation of the money supply that includes all elements of M1 as well as "near money." M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits. These assets are less liquid than M1 and not as suitable as exchange mediums, but they can be quickly converted into cash or checking deposits.

1:22

M2

BREAKING DOWN M2

In the “M”s classification system, which varies from country to country, M0 typically includes just notes and coins in circulation, as well as bank reserves in some cases. M1 often also includes traveler’s checks, demand deposits, as well as other checkable deposits. M2 includes these items as well as savings and time deposits in many cases. M3 as includes other elements like money market funds, large liquid assets and more. In the U.S., there are several other aggregates as well, including M4, which includes commercial paper and T-Bills besides the other components of M3.

M2 is a broader money classification than M1, because it includes assets that are highly liquid but are not cash. A consumer or business typically doesn't use savings deposits and other non-M1 components of M2 when making purchases or paying bills, but it could convert them to cash in relatively short order. M1 and M2 are closely related, and economists like to include the more broadly defined definition for M2 when discussing the money supply, because modern economies often involve transfers between different account types. For example, a business may transfer $10,000 from a money market account to its checking account. This transfer would increase M1, which doesn’t include money market funds, while keeping M2 stable, since M2 contains money market accounts.

The Money Supply

M2 as a measurement of the money supply is a critical factor in the forecasting of issues like inflation. Inflation and interest rates have major ramifications for the general economy, as these heavily influence employment, consumer spending, business investment, currency strength and trade balances. In the United States, the Federal Reserve publishes money supply data every Thursday at 4:30 p.m., but this only covers M1 and M2. Data on large time deposits, institutional money market funds and other large liquid assets are published on a quarterly basis, and are included in the M3 money supply measurement.

Changes in Money Supply

In the United States, M2 has grown along with the economy, rising from $4.6 trillion in January 2000 to $12.8 trillion in June 2016. The supply never shrank year-over-year (YOY) at any point in that period. The most extreme growth occurred in September 2001, January 2009 and January 2012, when the rate of M2 expansion topped 10%. These accelerated periods coincided with recessions and economic weakness, during which expansionary monetary policy was deployed by the central bank. As of March 2018, the United States' M2 money supply totaled $13.86 trillion. 

In response to economic weakness, central banks often enact policy that increases the money supply, promotes inflation and reduces interest rates. This creates incentive for businesses to invest and for consumers to maintain their purchase activities. The Phillips Curve illustrates an inverse relationship between interest rates and unemployment, and the Federal Reserve's mandate is to balance these two important macroeconomic statistics. M2 provides important insight into the direction, extremity and efficacy of central bank policy.