Introduction
As a finance expert, I often get asked whether money market mutual funds (MMMFs) fall under M1 or M2 in the Federal Reserve’s monetary aggregates. The answer isn’t straightforward because it depends on the type of MMMF and how liquid it is. In this article, I’ll break down the classification, explain the differences between M1 and M2, and explore why some MMMFs are excluded from these measures.
Table of Contents
Understanding M1 and M2
Before diving into MMMFs, let’s clarify what M1 and M2 represent:
- M1: The most liquid forms of money, including:
- Physical currency and coins in circulation
- Demand deposits (checking accounts)
- Other liquid deposits like NOW accounts
- M2: A broader measure that includes M1 plus:
- Savings deposits
- Small-denomination time deposits (under $100,000)
- Retail money market mutual funds (non-institutional)
The Federal Reserve tracks these aggregates to gauge money supply and economic activity.
Where Do Money Market Mutual Funds Fit?
Money market mutual funds (MMMFs) are investment vehicles that invest in short-term, high-quality debt like Treasury bills and commercial paper. They offer high liquidity and stability, but their classification in M1 or M2 depends on their type.
Retail vs. Institutional MMMFs
- Retail MMMFs (for individual investors) are included in M2.
- Institutional MMMFs (for corporations and large investors) are excluded from both M1 and M2.
Why? Because the Fed considers retail MMMFs sufficiently liquid to be near-money, while institutional MMMFs are seen as less accessible for everyday transactions.
Historical Context
Before 2020, some MMMFs were included in M1, but regulatory changes (like the SEC’s Rule 2a-7) and the Fed’s reclassification shifted them to M2. The 2020 redefinition expanded M1 to include savings deposits, but MMMFs remained in M2.
Mathematical Representation of Monetary Aggregates
To understand how MMMFs fit into M1 and M2, let’s express them mathematically:
M1 = \text{Currency} + \text{Demand Deposits} + \text{Other Liquid Deposits} M2 = M1 + \text{Savings Deposits} + \text{Small Time Deposits} + \text{Retail MMMFs}Notice that institutional MMMFs are absent—they’re part of broader measures like M3 (which the Fed discontinued in 2006).
Why Aren’t All MMMFs in M1?
The Fed’s logic is based on liquidity and transactional use:
- M1 = Money used for immediate spending (high liquidity).
- M2 = Money that can be quickly converted to cash but isn’t used for daily transactions.
Since most MMMFs require selling shares to access cash, they aren’t as liquid as checking accounts. However, retail MMMFs are still considered near-money, hence their inclusion in M2.
Example: Calculating M1 and M2 with MMMFs
Let’s say:
- Currency in circulation = $2 trillion
- Demand deposits = $3 trillion
- Savings deposits = $5 trillion
- Retail MMMFs = $1 trillion
Then:
M1 = 2 + 3 = 5 \text{ trillion} M2 = 5 (M1) + 5 + 1 = 11 \text{ trillion}If institutional MMMFs were included (say, $2 trillion), they wouldn’t affect M1 or M2.
Comparison Table: M1 vs. M2 Components
| Component | Included in M1? | Included in M2? |
|---|---|---|
| Physical currency | Yes | Yes (via M1) |
| Checking accounts | Yes | Yes (via M1) |
| Savings accounts | No | Yes |
| Retail MMMFs | No | Yes |
| Institutional MMMFs | No | No |
Implications for Investors
If you’re holding retail MMMFs, they’re part of M2, meaning they’re considered stable but not as liquid as cash. Institutional MMMFs, however, don’t factor into the Fed’s money supply metrics, which affects how economists view market liquidity.
Conclusion
Money market mutual funds are not in M1 but are included in M2 if they’re retail funds. Institutional MMMFs fall outside both categories. Understanding this distinction helps in assessing liquidity risks and monetary policy impacts.
