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Definition of M1:
is the most limiting measure of the money supply. It includes only the most liquid of assets: currency in circulation, demand deposits, and traveler’s checks.
There are several measures of money. Cash is accepted everywhere. But what about money in a traditional savings account that does not have check writing privileges? Technically it is not money, because it is not accepted as a medium of exchange. However it certainly is “near money” because it can be converted into cash within hours. In other words, it is liquid enough that most would consider deposits in a savings account as money. Economists use two measures of money depending upon the asset’s liquidity. M1 is the most limiting measure because it does not include savings accounts. M2 includes M1 and savings accounts.
M1 includes currency (cash and paper money) in circulation, demand deposits, and traveler’s checks. The best test for M1 is to ask “Would most merchants accept this as payment when buying an item in a store?” If the answer is “Yes” then it is probably included in M1. Merchants normally accept currency, a check, or a traveler’s check. They do not accept money that is in a passbook savings account because the money has not been withdrawn. Currency includes coins and paper money. Checks are written out of accounts with demand deposits. Demand deposits can be withdrawn any time without penalty. There is no limit on the number of deposits or withdrawals that can be made from a demand account. Interest may be paid on these deposits, but the interest rate is normally very low. Checking accounts are the most common demand deposit accounts. Has a friend ever jokingly said, “I have checks, so I must have money.”? When the check bounces it demonstrates that checks themselves are not money – they only represent money deposited in a demand account. Checks provide instructions for a bank to transfer funds from one bank account to another.
The pie chart below illustrates that demand deposits comprised most of M1 in January 2016. The graph illustrates the growth of M1 and M2 since 2000. The increase following the Great Recession resulted from the Federal Reserve adding liquidity to the economy.
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