Discuss the changes that have and will in the future affect the usefulness of the M1 and M2 money supply figures as indicators of monetary policy

Answer 1

During the 1980s, the increasing popularity of interest-earning checking accounts caused a large increase in the growth of the M1 money supply. Because interest-earning checking accounts are included in M1, the switch away from savings accounts (and other types of investments only counted in M2) into interest-earning checking accounts increased the growth of M1 while M2 was unaffected. Because a large portion of U.S. currency is held outside the country by foreigners, it is difficult to measure the supply of money available for domestic transactions. This affects both M1 and M2, but since currency makes up a smaller proportion of M2, it distorts this figure the least.

Recently, banks have begun switching their customers from interest-earning checking accounts to money market deposit accounts. Because interest-earning checking accounts are included in M1 and M2, but money market deposit accounts are only counted in M2, this has lowered the size of M1 but has not affected M2 . The increasing availability of stock and bond mutual funds, which are not counted in either the M1 or M2 money supply, has caused both to be distorted, particularly M2, because most of the money put into these mutual funds has come from other investments counted as part of M2 but not M1.

The increasing use of debit cards and electronic money will also impact the money supply. Debit cards allow individuals to keep their money on deposit at the bank, rather than carrying the money in the form of cash. Higher deposits at banks will mean an expansion in the money supply.