In general terms define and explain the difference between t

In general terms define and explain the difference between the two monetary aggregates M1 and M2. (I do not want just a list of the components of either monetary aggregate).

Solution

As we know in general, M1 consists of currency and coins in circulation, checking accounts and traveller\'s cheque. Whereas M2 includes, M1 + saving accounts,small time deposits and money market funds.

The difference between the two lies with the fact that M2 is a broader classification of M1, because it includes assets that are highly liquid, but are not cash (which M1 is as it includes cash, currency and coins with public). So a consumer/business organisation won\'t use non-M1 component of M2 (savings deposit or time deposit) to make payments, rather it would convert it into cash.

Another point of difference is that the money supply M1 functions as medium of exchange and M2 functions as the store of value. When a consumer puts his money into his checking account, this is a part of M1. This money in checking account is liquid, he can easily take out his money and use for purchases. Whereas, if the same consumer puts his money into saving accounts (rather than checking account), this forms the part of M2, the consumer has used the money as a function of store of value, where he would earn an interest as well as protect himself from purchasing power of his initial deposit.