What it means
The money supply is layered by liquidity, and M2 sits one step out from the narrow M1 measure. It takes everything in M1 and adds savings deposits, small time deposits such as retail certificates of deposit, and retail money market fund balances.
The logic is that these balances are not usable for a transaction this second, but they can be converted into spending money within days at little or no cost. That makes them part of the purchasing power households actually have available, even if they are not sitting in a current account.
M2 is watched more closely than M1 because it is less distorted by people shuffling money between account types. If a household moves $20,000 from a current account into a savings account, M1 may change but M2 does not, so M2 gives a steadier read on the underlying stock of money.
The classic use is the quantity theory relationship, where the money stock multiplied by how fast it circulates equals nominal output. In practice velocity is unstable, which is why persistent attempts to manage the economy by targeting M2 growth were largely abandoned in favour of inflation targeting.
Even so, M2 retains diagnostic value at extremes. Very large expansions, such as those following major crisis-era stimulus, and outright contractions in M2 are both unusual enough that they draw serious attention from forecasters.
For a non-economist the practical reading is simple. M2 growth tells you roughly how fast the pool of money available to be spent is expanding, and comparing that pace with the growth in goods and services being produced gives a crude sense of whether prices are likely to be under upward or downward pressure.
In practice
Real-world examples.
Example
A fixed income fund manager notices M2 contracting for three consecutive quarters, an unusual pattern. He reduces exposure to companies with heavy short-term refinancing needs on the view that credit is tightening.
Example
A national brewer's planning team uses M2 growth alongside wage data when setting price increases for the coming year. The aim is to avoid raising prices faster than the money available to customers is growing.
Example
A journalist writing about pandemic-era stimulus explains an unusually steep rise in M2 to readers, linking it to direct payments and heavy government borrowing rather than to bank lending.
Think of it
“M2 is broader money supply-M1 plus savings and similar accounts.
Formula
Calculation
M2 = M1 + Savings deposits + Small time deposits + Retail money market fund balances
The figures used here are illustrative round numbers to demonstrate the calculation, not published statistics.
M1: $17,800 billion (already including savings deposits under the current US definition)
Small time deposits: $1,200 billion
Retail money market funds: $2,000 billion
M2 = $17,800bn + $1,200bn + $2,000bn = $21,000 billion, or $21 trillion
Velocity of money can then be estimated. If nominal GDP in this illustrative economy is $29,400 billion:
Velocity = Nominal GDP / M2 = $29,400bn / $21,000bn = 1.4
That means each dollar of M2 supports $1.40 of annual output. If M2 grew 6% next year while velocity stayed at 1.4, nominal GDP would grow 6% too, split between real growth and inflation.Case study
Seen in the real world.
This illustrative and fictional case concerns Tallowmere Kitchens, an invented mid-sized furniture manufacturer with $120,000,000 of annual revenue. Its board used a simple internal rule of thumb: budget nominal revenue growth roughly in line with M2 growth in its main market, adjusted for its own market share plans.
In the fictional scenario, M2 had grown about 11% during a stimulus period, and Tallowmere budgeted for a strong year. Demand did surge, but so did input costs, and the finance director noted that the same money growth feeding revenue was also feeding the 14% rise in timber and steel prices the company was paying.
The lesson recorded in the illustrative case was that money aggregates say something about nominal amounts, not real ones. Tallowmere revised its rule to plan volumes and prices separately, using M2 only as a sense check on the nominal total rather than as a forecast of real growth.
Watch out
Common mistakes.
- Assuming M2 growth translates directly into inflation, when velocity and output growth both sit between the two.
- Comparing M2 across countries or across long time periods without allowing for definitional changes.
- Treating M2 as a measure of wealth, when it counts only monetary balances and excludes property, shares and pensions.
Questions
People also ask.
What is the difference between M1 and M2?
M2 includes everything in M1 plus savings-type balances that take a little longer to turn into spendable cash.
Why do central banks not simply target M2?
Because the link between money growth and inflation is unstable, so most now target inflation directly using interest rates.
Can M2 fall?
Yes, and it did in some economies during the tightening cycle that followed the pandemic-era expansion, which is historically rare.
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