When diving into the intricacies of monetary policy and economic classifications, a common question I often encounter is whether non-institutional money market fund shares fall under the M1 or M2 categories of the money supply. This question isn’t just for economists or finance professionals—it’s something that anyone involved in investments, particularly in money market funds, should understand.
To answer this question thoroughly, I’m going to walk through a breakdown of what M1 and M2 actually are, what non-institutional money market funds are, and where these funds fit in the broader monetary framework. I’ll also discuss the differences between these two categories of the money supply and illustrate how non-institutional money market funds impact and relate to these classifications. By the end of this article, you should have a clear understanding of where these funds stand and how they fit into the economy.
Table of Contents
What is M1 and M2?
Before we get into the heart of the question, it’s essential to understand the difference between M1 and M2 money supply categories. Both of these represent different measures of the money supply in an economy, but they include different components.
M1 Money Supply
M1 is the most liquid form of money available in an economy. It represents money that is either already in circulation or can quickly and easily be converted into cash. The components of M1 include:
- Currency in circulation: This includes all the physical money—paper bills and coins—held by the public.
- Demand deposits: These are checking accounts held at financial institutions, which can be accessed at any time without restrictions.
- Other checkable deposits: This includes negotiable order of withdrawal (NOW) accounts, automatic transfer service (ATS) accounts, and credit union share draft accounts.
- Traveler’s checks: While these are not as common as they once were, they are still considered part of M1 when issued by non-bank institutions.
M2 Money Supply
M2 is a broader measure of the money supply than M1, as it includes all of M1 plus additional forms of money that are less liquid. M2 includes:
- M1 components: All the components listed above for M1.
- Savings accounts: Money stored in savings accounts, which are not as easily accessed as checking accounts.
- Time deposits: Certificates of deposit (CDs) with a fixed term and higher interest rates. They are less liquid since they cannot be accessed before the term expires without incurring penalties.
- Money market deposit accounts (MMDAs): These are interest-bearing accounts with limited check-writing abilities.
- Retail money market mutual funds: These are funds that invest in short-term debt securities, including Treasury bills, commercial paper, and other short-term investments. While these are more liquid than time deposits, they are still a step removed from being immediately accessible like the components of M1.
What are Non-Institutional Money Market Funds?
Non-institutional money market funds (MMFs) are a specific type of investment fund. These funds are designed to invest in short-term, high-quality instruments like Treasury bills, certificates of deposit (CDs), and commercial paper. The distinguishing feature of non-institutional MMFs is that they are generally accessible to individual investors, unlike institutional money market funds, which cater to businesses, large corporations, or other institutional investors.
The primary goal of these funds is to provide investors with a safe and highly liquid place to park their cash while earning a modest return, typically in the form of interest. These funds are often seen as low-risk investments, making them a popular choice for conservative investors who want to keep their money relatively safe while still earning some yield.
How Non-Institutional Money Market Fund Shares Relate to M1 and M2
Now that we understand the basic definitions of M1 and M2, we can focus on where non-institutional money market fund shares fit into the broader money supply categories. To clarify the relationship between non-institutional money market fund shares and M1/M2, I’ll explain the following:
- Non-Institutional MMFs and M1: Non-institutional money market funds are not a part of M1. The primary reason for this is that M1 includes only those forms of money that are highly liquid, such as currency and demand deposits. Non-institutional money market funds, while relatively liquid, are not as easily accessed as cash or checking accounts. Therefore, they don’t qualify for inclusion in M1.
- Non-Institutional MMFs and M2: Non-institutional money market funds do, however, fall under M2. M2 includes money market deposit accounts and retail money market mutual funds, both of which are highly liquid forms of money but are less liquid than the assets included in M1. Since non-institutional MMFs are designed to be liquid and accessible, but not as immediately available as the components of M1, they are included in M2.
Key Points to Remember
To summarize:
| Category | M1 | M2 |
|---|---|---|
| Components | Currency, demand deposits, traveler’s checks | M1 components + savings accounts, time deposits, retail MMFs |
| Liquidity | High liquidity, easily accessible | Broader, includes less liquid assets |
| Non-Institutional Money Market Funds | Not included | Included |
Non-institutional money market funds are part of M2 because they represent a form of highly liquid, but slightly less accessible money compared to the components of M1.
Why Does This Matter?
Understanding where non-institutional money market fund shares fall within the money supply categories has implications for several areas of economic policy and personal investment strategy.
Impact on Monetary Policy
Monetary policymakers, such as the Federal Reserve, monitor the M1 and M2 money supplies to gauge the overall health and liquidity of the economy. Changes in M2 can be indicative of shifts in consumer spending, savings behavior, and overall economic activity. Since non-institutional money market funds are a part of M2, fluctuations in these funds can impact M2 growth, which in turn can inform policy decisions.
Impact on Investors
As an investor, understanding the classification of your investments within the broader money supply helps in assessing the liquidity and risk associated with your portfolio. Non-institutional money market funds offer a safe place to park cash, but because they are considered part of M2, their returns may not be as high as riskier assets included in other categories of the money supply.
Additionally, the liquidity of non-institutional MMFs makes them a popular choice during times of economic uncertainty. Their position in M2 makes them less affected by immediate shifts in market conditions compared to the cash-heavy components of M1.
Examples and Illustrations
Let’s illustrate the differences between M1 and M2 further with some practical examples.
Example 1: M1 Components
I decide to keep $10,000 in cash in my wallet. This cash is counted as part of the M1 money supply because it is immediately accessible for spending and has a high level of liquidity. Additionally, if I place this amount in a checking account, it remains part of M1 since I can easily access it at any time.
Example 2: M2 Components
Now, let’s say I invest $10,000 into a non-institutional money market fund. This money is not as easily accessible as cash, but it is still fairly liquid, meaning I can convert it into cash within a short period. Therefore, it is included in M2, but not in M1.
The difference here is clear: cash and demand deposits are part of M1 because they can be immediately accessed, whereas investments like money market funds are part of M2 due to their slightly reduced liquidity.
Conclusion
In conclusion, non-institutional money market fund shares fall under M2, not M1. The key difference between these two categories lies in their liquidity. While M1 is the narrowest and most liquid measure of the money supply, M2 includes a broader range of assets, including non-institutional MMFs, which are liquid but not as immediately accessible as M1 components.
Understanding this distinction is crucial for both policymakers and investors. For me, as an investor, knowing that non-institutional money market funds are part of M2 allows me to assess the liquidity and role of these funds within the broader economic landscape. The classification of these funds also provides insight into their behavior during times of economic change.
If you’re considering investing in a non-institutional money market fund, knowing where these funds fit into the money supply helps you make more informed decisions about their potential risks and rewards in the context of broader monetary trends.
