Definition / Meaning of Money supply – M1

Money supply – M1 is a measure of the most liquid forms of money in an economy. It includes all physical currency (coins and paper money) in circulation outside of the U.S. Treasury, Federal Reserve banks, and the vaults of depository institutions, plus demand deposits, traveler’s checks, and other checkable deposits (like checking accounts). In simple terms, M1 is the money that people and businesses can spend immediately.

Components of M1

The Federal Reserve defines M1 as consisting of:

• Currency – All coins and paper money in circulation, excluding cash held by banks and the government.
• Demand deposits – Non-interest-bearing checking accounts that allow you to withdraw funds on demand.
• Other checkable deposits – Interest-bearing checking accounts, such as NOW (Negotiable Order of Withdrawal) accounts and credit union share draft accounts.
• Traveler’s checks – Though less common today, these are still counted as part of M1.

Why M1 Matters

M1 is a key indicator of the money supply that is immediately available for spending. Economists and policymakers monitor M1 to gauge the amount of liquidity in the economy. A rapid increase in M1 can signal rising inflationary pressure, as more money chases the same amount of goods and services. Conversely, a slow-growing or shrinking M1 may indicate a sluggish economy with weak consumer spending.

M1 vs. M2

M1 is the narrowest measure of the money supply. The next broader measure is Money supply – M2, which includes M1 plus less liquid forms of money such as savings deposits, money market deposit accounts, retail money market mutual funds, and small-denomination time deposits (certificates of deposit under $100,000). While M1 focuses on money that can be spent today, M2 includes money that can be converted into M1 relatively quickly.

How the Federal Reserve Influences M1

The Federal Reserve System (the Fed) controls the money supply through several tools. When the Fed wants to increase M1, it can buy government securities through open market operations, which injects reserves into the banking system and allows banks to create more checkable deposits. Lowering the reserve requirement also enables banks to lend more, expanding demand deposits. Conversely, the Fed can reduce M1 by selling securities or raising reserve requirements.

Historical Context

Before 2020, M1 included only currency, demand deposits, and traveler’s checks. In May 2020, the Federal Reserve revised its definition to include other checkable deposits (like savings accounts that allow unlimited transfers) because those accounts had become essentially as liquid as checking accounts. This change made M1 a more accurate measure of immediately spendable money.

Practical Example

Suppose you have $1,000 in cash in your wallet and $5,000 in your checking account. Together, that $6,000 is part of M1 because you can spend it instantly. If you also have $10,000 in a savings account that allows unlimited withdrawals (as many do after the 2020 rule change), that $10,000 would also be included in M1 under the new definition. Before 2020, only the cash and checking account balance counted.

Limitations of M1

While M1 is a useful measure, it does not capture the entire money supply. It ignores near-money assets that can be quickly converted to cash, such as savings deposits or money market funds. For a more complete picture, economists also look at M2 and Money supply – M3 (though the Fed stopped publishing M3 in 2006). Additionally, changes in M1 can be volatile in the short term due to shifts in bank lending and consumer behavior.

In summary, M1 is the most liquid slice of the money supply, representing the money that is ready and available for transactions. It is a vital statistic for understanding current economic activity and the potential for inflation or recession.