M2 Definition and Meaning in the Money Supply

What Is M2?

M2 is the U.S. Federal Reserve's estimate of the total money supply including all of the cash people have on hand plus all of the money deposited in checking accounts, savings accounts, and other short-term saving vehicles such as certificates of deposit (CDs). Retirement account balances and time deposits above $100,000 are omitted from M2.

The Federal Reserve tracks a separate money supply number, called M1, that includes currency that is in people's pockets or in checking accounts. The money that is deposited in savings accounts, certificates of deposit, and money market funds is not counted in M1. For the Fed's purposes, this is "near money." That is, the funds cannot be used as a medium of exchange and they are not instantly convertible to cash.

Understanding M2

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 measures 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 more comprehensive calculation than M1 because it includes assets that are highly liquid but are not intended to be routinely used as cash. Consumers and businesses don't usually use savings deposits or certificates of deposit when making purchases or paying bills, but in a pinch, they could convert them to cash in short order.

Economists usually use the broader M2 number when discussing the money supply because modern economies often involve transfers between different account types.

For example, a business may periodically transfer $10,000 from a money market account to a checking account. This transfer would increase M1, which doesn’t include money market funds, while keeping M2 stable, since M2 contains both accounts.

The Money Supply

M2 is a critical factor in the forecasting of inflation. Inflation and current interest rates have major ramifications for the general economy, as they heavily influence job availability, consumer spending, business investment, currency strength, and trade balances.

In the United States, the Federal Reserve publishes M1 and M2 money supply data every Thursday at 4:30 p.m.

Yet another "M," the M3, includes numbers on large-time deposits, institutional money market funds, and other large liquid assets. This is published on a quarterly basis.

Changes in Money Supply

The Federal Reserve's dual mandate is to balance unemployment and inflation. One of the ways it does this is by manipulating the M2 money supply.

The M2 numbers provide important insights into the direction, extremity, and efficacy of central bank policy. M2 has grown along with the economy, rising from $4.6 trillion in January 2000 to $18.45 trillion in August 2020. 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.

The economic fallout from the COVID-19 pandemic along with the economic stimulus efforts that followed also greatly expanded the money supply, with record quarterly increases in Q1 of 2021. In fact, February 2021 saw a year-over-year increase of 27.12%.

The Bottom Line

The Federal Reserve isn't keeping track of how much cash you've got in your wallet but it's got a pretty good idea of how much cash all of us have on hand at any given time. In late 2022, it was $21 trillion or so.

The important point isn't the number but how the number is increasing or decreasing from month to month. Too much cash is seen as a warning sign of a growing threat of inflation.