Gary Goldwater has $5,000 in cash. He deposits $1,000 in his checking account, buys $500 of traveler's checks, puts $1,500 in his money-market mutual fund, and buys a $2,000 CD. How does this transaction affect M1 and M2?
What will be an ideal response?
The $5,000 in cash was in M1, therefore also in M2. Of the $5,000, he keeps $1,500 in accounts that are part of M1 (checking account + travelers checks). Since he puts $1,500 in his money-market mutual fund, M1 declines by $5,000 ? $1,500 = $3,500. Both the MMMF and CD are part of M2, so M2 does not change.
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