Understanding Money Supply Categories

Key Takeaways

1. 1M0 (base money) is physical currency plus bank reserves held at the central bank — the layer the Fed directly controls
2. 2M1 (transaction money) is M0 plus checking deposits — the money used for daily spending and instant transactions
3. 3M2 (broader money) is M1 plus savings deposits and money market accounts — money one step away from being spent
4. 4Central banks directly control M0 by issuing currency and managing reserves; M1 and M2 depend on bank lending and household behavior
5. 5Money supply growth should track economic growth — too slow causes deflation, too fast causes inflation
6. 6During crises, M1 can contract sharply even as M0 expands — lending freezes and customers pay down debts, breaking the transmission
7. 7Inflation is measured against M2 because it captures money saved for future spending, not just today's transactions
8. 8Digital money and cryptocurrency (stablecoins, money market funds, CBDCs) are blurring the boundaries between traditional money supply categories