How to Read the Money Supply M1 and M2 — How Much Money Is Circulating in the World?
The phrase "there is ample liquidity in the market" — what exactly is it measured by? The indicators that serve as that thermometer are the money-supply measures M1 and M2.
M1 — Money You Can Use Right Now (Narrow Money)
M1 is an indicator that gathers "money you can use as a means of payment right now," and it is called "narrow money."
Specifically, it includes the cash people hold (currency in circulation) and demand deposits and instant-access savings deposits that can be withdrawn and used at any time. In a word, it is "the most liquid money."
M2 — Money Seen a Bit More Broadly (Broad Money)
M2 is an indicator that adds to M1 "money that can be converted to cash with just a little time," and it is called "broad money."
In addition to M1, it includes time deposits and installment savings with a maturity of less than two years, certificates of deposit (CDs), money market funds (MMFs), residents' foreign-currency deposits, and so on. They are not completely usable on the spot, but they are assets that can be converted to cash relatively easily without much loss.
Generally, when talking about market liquidity, people look at M2 more often. If M2 grows quickly relative to the size of the economy, it is interpreted as liquidity being ample.
The detailed components of M1 and M2 differ slightly by country (the United States, Korea), and the standards can be revised. For precise definitions, check the latest standards of each country's central bank.
The Money Supply and Investors
The money supply shows "how much money has been released," but an increase in the money supply does not necessarily mean prices or asset prices will immediately rise.
The released money must actually circulate into spending and lending (the velocity of money) to affect the economy. If liquidity stays in banks, prices can remain quiet even as the money supply grows.
So treat the money supply as a reference indicator for reading the big flow of liquidity, and rather than concluding about the market from this alone, it is safer to look at it together with interest-rate, price, and economic indicators.
Preguntas frecuentes
Q. If M1 grows, do prices rise?
There is no direct formula. For an increase in the money supply to lead to prices, that money must actually circulate into spending and investment. Even if money grows, if it does not circulate well (falling velocity), prices can remain quiet, so you cannot conclude about prices from the money supply alone.
Q. Is there an indicator broader than M2?
Yes. Depending on the country, broader indicators than M2 such as Lf (liquidity aggregates of financial institutions) or L (broad liquidity) are used together. The broader the scope, the more diverse the financial products included when viewing liquidity.
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