What Is Money Supply? M1 vs. M2 vs. M3

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The money supply is the total stock of money held by the public in an economy at a given point in time: currency in circulation plus deposits and other balances that can be spent or quickly converted into spendable money. Central banks do not publish a single number. They publish several “monetary aggregates,” labeled M0, M1, M2 and (in some countries or in the past) M3 or M4. Each one draws the boundary of “money” in a different place. In the U.S., the Federal Reserve calls these figures the money stock and reports M1 and M2 in its H.6 release.

The short version of M1 vs. M2 vs. M3:

• M1 (narrow money): currency held by the public plus demand deposits, other checkable deposits and, since 2020, savings deposits.
• M2 (broad money): M1 plus small-denomination time deposits and retail money market fund balances.
• M3 (broader money, discontinued in the U.S.): M2 plus large time deposits, institutional money market funds and certain other large, short-term liabilities. The Fed stopped publishing it in 2006.

What Is Money Supply?

Money supply measures how much money exists in a form people and businesses can use to buy things. The key word is liquidity: how quickly and cheaply an asset can be turned into a means of payment without losing value. Cash is perfectly liquid. A checking balance is nearly as liquid. A six-month certificate of deposit is money you can get back early, usually with a penalty. A share of stock is not counted at all, because selling it exposes you to price risk and takes time to settle.

Several measures exist because there is no single correct answer to where “money” ends. A narrow measure captures what is ready to spend today; a broad one captures what households could shift into spending with modest effort.

Money supply is also a stock concept. It answers “how much money is there right now?”, the way a bank balance does, rather than “how much was spent this year?”, which is a flow, like GDP. The figure is usually stated in nominal terms (current dollars). Dividing it by a price index such as the Consumer Price Index gives the real money supply, which shows the purchasing power of that stock.

How Money Supply Works

The Measures, From Narrowest to Broadest

M0 and the monetary base (MB). The monetary base is currency in circulation plus the reserve balances commercial banks hold at the central bank. Some textbooks use M0 for the same idea; others use M0 for physical currency only. The base is the raw material the central bank directly controls. It is not simply “inside” M1: M1 counts currency held by the public, while bank reserves sitting at the Fed are excluded from M1 and M2.

M1. M1 is the narrow, spendable measure:

M1 = currency held by the public + demand deposits + other liquid deposits (other checkable deposits and savings deposits)

Before May 2020, savings deposits were part of M2 only. The Fed moved them into M1 after removing the regulatory limit on monthly savings withdrawals, since savings accounts had become about as liquid as checking accounts. That redefinition caused a large one-time jump in reported M1, so M1 figures from before and after 2020 are not directly comparable.

M2. M2 adds near-money to M1:

M2 = M1 + small-denomination time deposits (under $100,000) + retail money market fund balances

These assets are not usually used to pay for things directly, but they can be moved into checking quickly. M2 is the measure most often cited in discussions of inflation and monetary conditions.

M3. M3 added large time deposits, institutional money market fund balances, repurchase agreements and eurodollar deposits to M2. The Federal Reserve ended M3 publication in March 2006, concluding that it added little information beyond M2 and was not used in policy decisions, while collecting the data carried a cost.

M4 and other national measures. Definitions vary by country. The Bank of England, for example, has long used M4 as its broad money measure. When comparing countries, check each central bank’s definition rather than assuming M2 means the same thing everywhere.

Where Money Comes From

Most money in a modern economy is bank deposits, not cash. The central bank creates base money, chiefly through open market operations: when it buys Treasury securities from banks or dealers, it pays by crediting their reserve accounts, adding new reserves to the system. Selling securities does the reverse.

Commercial banks create most of the rest when they lend. A loan credits the borrower’s account with a new deposit, and that deposit is counted in M1 or M2. When loans are repaid, deposits shrink. How far deposits grow relative to the base depends on the classic determinants of the money supply:

• Currency-deposit ratio (c): how much cash the public holds relative to deposits. More cash held outside banks leaves less to support lending.
• Required reserve ratio (r): the share of deposits banks must hold as reserves. The Fed cut this to zero in March 2020.
• Excess reserve ratio (e): reserves banks choose to hold beyond any requirement.

The textbook money multiplier formula ties these together:

Money multiplier = (1 + c) / (c + r + e)

Money supply = money multiplier × monetary base

Interpreting Money Supply

Changes in the aggregates are read in context. Rapid growth in M2 can mean the central bank is easing, banks are lending more, or people are moving funds out of stocks and bonds into deposits. A shift between measures (for example, money leaving time deposits for checking accounts) can change M1 without changing M2. Growth rates matter more than levels, and comparisons with output and prices matter more than either.

Example of Money Supply

Hypothetical example, for illustration only. Assume an economy with a monetary base of $1,000 billion, a currency-deposit ratio of 0.25, a required reserve ratio of 0.10 and an excess reserve ratio of 0.05.

Multiplier = (1 + 0.25) / (0.25 + 0.10 + 0.05) = 1.25 / 0.40 = 3.125

Money supply = 3.125 × $1,000 billion = $3,125 billion

Now assume banks become cautious and raise excess reserves to 0.15, with everything else unchanged:

Multiplier = 1.25 / (0.25 + 0.10 + 0.15) = 1.25 / 0.50 = 2.5

Money supply = 2.5 × $1,000 billion = $2,500 billion

The central bank did nothing, yet the money supply fell by $625 billion because banks held more reserves instead of lending. This is the mechanism behind a “credit crunch.”

A simpler household view shows the nesting of the measures. Suppose a household holds $300 in cash, $2,000 in checking, $5,000 in savings, a $10,000 one-year CD and $3,000 in a retail money market fund. Under current U.S. definitions, $7,300 counts toward M1 and the full $20,300 counts toward M2. Before 2020, the $5,000 savings balance would have counted only in M2.

Why Is Money Supply Important?

More money relative to the goods and services an economy produces tends to push interest rates down and spending up. Cheaper borrowing encourages businesses to invest and households to take on mortgages and car loans; firms order more inputs and hire more workers. Slower money growth works in the opposite direction: banks lend less, projects are postponed and demand cools.

The best-known framework linking money to prices is Irving Fisher’s quantity theory of money, expressed through the equation of exchange:

M × V = P × Y

where M is the money supply, V is velocity (how often each dollar is spent in a period), P is the price level and Y is real output. If V and Y were stable, faster growth in M would show up mostly as higher P, meaning inflation. Monetarism, associated with Milton Friedman, built on this idea and argued that central banks should target steady money growth.

When the Fed wants to restrain inflation, it pursues contractionary (hawkish) policy: higher policy rates, asset sales or a smaller balance sheet, all of which slow money and credit growth and raise borrowing costs. The risk is overshooting, slowing growth enough to raise unemployment. Expansionary policy does the reverse, buying securities and lowering rates to encourage lending.

Money demand is the other half of the picture. People hold money for transactions and as a precaution, and the opportunity cost of doing so is the interest they could earn elsewhere. When interest rates rise, households tend to move funds out of zero-interest checking into higher-yielding assets, which can shrink M1 even if overall wealth is unchanged.

Limitations of Money Supply

The link to inflation is unstable. The relationships between money growth, inflation and output that looked reliable in earlier decades became less predictable from around 2000 onward. Velocity moves around, so a given change in M does not translate into a predictable change in prices. The Fed now treats the aggregates as one input among many rather than a policy target.

The Fed does not control the totals directly. It controls the monetary base and its policy interest rate. M1 and M2 also depend on bank lending decisions and public preferences between cash, deposits and other assets.

Boundaries are arbitrary. Some highly liquid assets fall outside M2, such as institutional money market funds after M3 ended, Treasury bills held directly, and balances in payment apps or crypto assets. Bitcoin and similar assets are excluded because their prices fluctuate and they are not liabilities of banks or the central bank, which is what the official aggregates measure. As payments shift toward digital wallets and other channels, what households treat as money and what the aggregates count can drift apart.

The multiplier is a simplification. With zero reserve requirements and banks holding large reserve balances, lending is constrained more by capital rules, loan demand and risk appetite than by reserves. The formula is useful for showing how ratios interact, not for forecasting.

M1 vs. M0, M1 vs. M2: Common Confusions

• M0 vs. M1: the monetary base includes bank reserves at the central bank; M1 excludes them but adds deposits, so M1 is not strictly “M0 plus something.”
• M1 vs. M2: M1 is money ready to spend; M2 adds near-money and is always larger.
• Money vs. wealth: a stock portfolio or home is wealth but not money supply.
• Money supply vs. the Fed’s balance sheet: the balance sheet relates to the monetary base, while M2 also depends on bank behavior, so they can move in different directions.

The Bottom Line

Anyone reading M1 or M2 figures to judge inflation or monetary conditions needs to know which measure is being cited and how it is defined. Growth rates, read against output and prices, say more than raw levels. Because velocity shifts and bank lending drives most deposit creation, the aggregates work best as one signal among many, and M1 data from before and after 2020 should not be compared directly.