M2

The M2 is a measure of the money supply that includes M1 plus savings deposits, money-market funds, small time deposits, and other assets that are nearly as liquid as cash. M2 is broader than M1 but narrower than M3, and it is the most commonly cited money supply measure by central banks and economists.

Components of M2

M2 = M1 + Savings deposits + Money-market funds + Small time deposits + Other near-monies

M1 (currency + demand deposits, as discussed in the M1 entry)

Savings deposits: Money in savings accounts—accessible but not instantly spendable. You can withdraw it quickly, but not with a debit card or check. A bank might take a day or two to process the withdrawal.

Money-market funds: Mutual funds investing in short-term, low-risk securities (Treasuries, commercial paper, bonds). They offer slightly higher returns than savings accounts and are highly liquid—you can sell your shares and get cash within a day.

Small time deposits: CDs (certificates of deposit) and similar accounts where you lock up money for a specified period (6 months, 1 year, etc.) in exchange for a fixed interest rate. These are less liquid than savings accounts.

Other near-monies: Some central banks also include retail money-market funds, stock-market mutual funds, and other liquid but slightly riskier assets in their M2 definition.

Why M2 is the preferred measure

Central banks and economists typically focus on M2, not M1 or M3, because M2 strikes a balance:

• It is broad enough to capture meaningful changes in credit and liquidity throughout the financial system.
• It is narrow enough to focus on assets that are truly close to cash, excluding assets (like stocks or bonds) that fluctuate sharply in value.
• It has a long historical time series, allowing comparisons across decades.

The Federal Reserve publishes M2 every two weeks and watches it closely as an indicator of economic activity and inflation risks.

M2 and the credit cycle

M2 grows when banks are lending aggressively (credit expansion) because the loans create deposits, which are part of M1 and hence M2. Conversely, M2 contracts when banks are retrenching (credit contraction) or when the central bank is tightening.

During the 2008 financial crisis, M2 growth slowed sharply as credit markets froze. Liquidity was scarce, and banks were hoarding reserves. Once the Fed began quantitative easing and provided liquidity, M2 rebounded.

M2’s trajectory during COVID

Like M1, M2 surged during the COVID-19 pandemic. Government stimulus and Fed asset purchases created checking account deposits. Unlike M1, M2 also includes savings deposits, which swelled as households accumulated precautionary balances and spent less.

The explosive M2 growth was debated intensely. Some warned it was inflationary; others noted that much of the growth was temporary. The actual inflation outcome—moderate rather than severe—reflected both the temporary nature of the stimulus and the substantial decline in velocity (the rate at which money circulates).

M2 targeting

Some economists and central banks have experimented with M2 targeting—explicitly setting a growth rate for M2 and using monetary policy to hit it. The Federal Reserve adopted M2 targeting in the 1970s and 1980s, but abandoned it in the 1990s because the relationship between M2 and inflation proved unstable.

Modern central banks prefer to target interest rates or inflation directly, rather than targeting money supply aggregates like M2.

See also