In the complex ecosystem of global economics, the “money supply” is a term frequently used by analysts, central bankers, and financial journalists to describe the total amount of monetary assets available in an economy at a specific time. However, money is not a monolithic concept. To better understand how capital flows through an economy, economists categorize money into different “aggregates,” labeled M0, M1, M2, and M3. Among these, M1 represents the most liquid forms of money—the capital that is most readily available for spending and immediate transactions.
Understanding what is included in M1 is essential for anyone looking to grasp the fundamentals of personal finance, inflation, and the broader economic landscape. As the “narrowest” measure of money, M1 serves as a barometer for consumer spending power and the immediate liquidity within a nation’s financial system.
The Core Components of M1: The Definition of Liquidity
At its most basic level, M1 consists of currency and assets that can be converted into currency almost instantly without a significant loss in value. These are the tools we use for our daily transactions, from buying a cup of coffee to paying a monthly utility bill. The composition of M1 is defined by its high degree of liquidity, meaning it is “ready to go” money.
Currency in Circulation
The most recognizable component of M1 is physical currency. This includes all the paper bills (banknotes) and metal coins issued by a government’s treasury or central bank that are currently held by the public. It is important to note that “currency in circulation” does not include the cash held in bank vaults or the reserves held at the Federal Reserve. It specifically refers to the cash in the pockets, wallets, and cash registers of individuals and businesses.
While we are moving toward a more digital society, physical currency remains a foundational element of M1. It represents the ultimate form of liquidity because it is universally accepted as legal tender for all debts, public and private.
Demand Deposits
The second major pillar of M1 is demand deposits. These are the funds held in checking accounts at commercial banks. They are called “demand” deposits because the account holder has the legal right to withdraw the funds or transfer them to a third party at any time, on-demand, without prior notice.
In the modern era, demand deposits are moved via debit cards, electronic transfers, and paper checks. Because these funds are used for the vast majority of consumer and business transactions, they are considered a core part of the narrow money supply. If you have $2,000 in your checking account, that $2,000 is part of M1 because you can spend it immediately.
Other Checkable Deposits (OCDs)
Aside from standard checking accounts, M1 includes “Other Checkable Deposits.” This category traditionally included accounts that allowed for check-writing but might have functioned slightly differently than a standard demand deposit, such as Negotiable Order of Withdrawal (NOW) accounts and Automatic Transfer Service (ATS) accounts. While these terms are becoming less common in consumer banking jargon, they remain a technical component of the M1 aggregate to ensure all liquid, transaction-oriented accounts are accounted for.
The 2020 Pivot: Why Savings Accounts Are Now Included in M1
For decades, the definition of M1 was strictly limited to cash and checking accounts. Savings accounts were relegated to M2 because they were considered “near money.” Historically, Federal Reserve Regulation D limited the number of “convenient” withdrawals from savings accounts to six per month. This lack of immediate, unlimited liquidity meant savings accounts didn’t quite fit the definition of M1.
However, in May 2020, the landscape of the U.S. money supply shifted dramatically due to a regulatory change by the Federal Reserve.
The Amendment to Regulation D
In response to the economic shifts caused by the COVID-19 pandemic, the Federal Reserve eliminated the six-withdrawal limit on savings accounts. This change effectively blurred the line between a checking account and a savings account. Since consumers could now theoretically move money out of their savings accounts as frequently as they wished, the Fed decided that savings deposits should be reclassified.
The Statistical Surge
When the Federal Reserve integrated savings deposits into M1 in May 2020, the reported M1 money supply saw a massive, vertical spike on economic charts. It wasn’t that trillions of new dollars were suddenly printed in a single day; rather, money that was already sitting in savings accounts (previously part of M2) was “moved” into the M1 category for accounting purposes.
Today, when we ask “what is included in M1,” the answer includes the hundreds of billions of dollars sitting in traditional savings accounts and money market deposit accounts. This change has made M1 a much larger figure than it was historically, reflecting the evolving way that people interact with their bank accounts.
M1 vs. M2: Distinguishing Liquid Money from “Near Money”
To fully appreciate the significance of M1, it is helpful to contrast it with M2. If M1 is the money in your wallet and checking account, M2 is your total “ready” wealth.
The M2 Envelope
M2 is a broader classification of money. It includes everything found in M1, plus “near money.” Near money refers to assets that are highly liquid but not quite as “instant” as cash or a checking deposit. This includes:
- Small-denomination time deposits (CDs) of less than $100,000.
- Retail money market mutual fund shares.
Before 2020, savings accounts were the primary difference between M1 and M2. Now that savings are in M1, the gap between the two has narrowed in terms of account types, though M2 remains the larger figure because it includes time-locked assets like CDs.
The Liquidity Ladder
Think of the money supply as a ladder of liquidity. At the very bottom (the most liquid) is M0, which is just physical cash and bank reserves. M1 is the next step up, adding checking and savings deposits. M2 adds time-based deposits. As you move from M1 to M2 and beyond, the assets become less liquid and more focused on savings and investment rather than immediate transaction.
Why M1 Matters to Your Personal Finances and the Economy
The size and velocity of the M1 money supply are not just abstract numbers for economists to debate; they have real-world implications for your purchasing power, interest rates, and the health of your investment portfolio.
M1 and Inflation
One of the most critical relationships in finance is the link between the money supply and inflation. According to the Quantity Theory of Money, if the supply of money (M1) grows faster than the economy’s ability to produce goods and services, the value of each dollar tends to decrease. This results in rising prices, also known as inflation.
When M1 expands rapidly—whether through central bank policy, government stimulus, or the reclassification of savings—investors watch closely. If there is more liquid money chasing a limited supply of goods, the cost of living usually goes up. For the individual, a ballooning M1 can be a warning sign to look for inflation-hedging assets like real estate, commodities, or equities.
Central Bank Policy and Interest Rates
The Federal Reserve and other central banks monitor M1 to help determine monetary policy. If the economy is sluggish, the Fed may take steps to increase the money supply (and thus M1) by lowering interest rates or engaging in open market operations. Lower interest rates make it cheaper to borrow, which increases the amount of money flowing into checking accounts and businesses, stimulating spending.
Conversely, if M1 is growing too fast and fueling inflation, the Fed may raise interest rates. This encourages people to move money out of liquid M1 accounts and into interest-bearing M2 accounts or other long-term investments, effectively “sucking” liquidity out of the immediate spending pool to cool the economy.
The Velocity of Money
Simply having a high M1 isn’t enough to drive an economy; the money has to move. This is known as the “velocity of money.” It measures how many times a single dollar is spent on goods and services within a specific period. If M1 is high but people are hoarding cash and not spending, the velocity is low, and economic growth may remain stagnant. Investors look at the combination of M1 levels and velocity to gauge the true “heat” of the market.
The Future of M1: Digital Assets and CBDCs
As we look toward the future of money, the definition of M1 is likely to undergo further transformations. The rise of digital finance is challenging the traditional boundaries of what constitutes “liquid money.”
Are Cryptocurrencies Part of M1?
Currently, decentralized cryptocurrencies like Bitcoin or Ethereum are not included in the official M1 money supply. Although they are digital and can be transferred, they are classified as volatile assets or commodities by most regulatory bodies rather than “money.” However, as payment processors increasingly allow for instant crypto-to-fiat transactions at the point of sale, the argument for their inclusion in liquidity measures grows stronger.
Central Bank Digital Currencies (CBDCs)
Many nations are currently exploring the creation of Central Bank Digital Currencies (CBDCs). Unlike Bitcoin, a CBDC would be a digital form of a nation’s sovereign currency, issued directly by the central bank. If implemented, CBDCs would undoubtedly be included in M1. They would represent the ultimate evolution of currency in circulation—digital “cash” that resides in a government-backed digital wallet, offering the same or greater liquidity than the paper bills we use today.
Conclusion
M1 is the lifeblood of the daily economy. It represents the liquid resources that households and businesses have at their immediate disposal to fuel commerce. By understanding that M1 includes physical currency, demand deposits, and now savings accounts, you gain a clearer picture of the financial forces that drive inflation and interest rate trends.
Monitoring the M1 money supply allows you to see how “flush” the economy is with cash. In an era of rapid digital transformation and changing monetary policy, staying informed about these fundamental components is essential for making savvy personal finance decisions and understanding the true value of the dollars in your pocket. Whether you are an investor, a business owner, or a saver, the fluctuations in M1 provide a roadmap for the future of your purchasing power.
aViewFromTheCave is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. Amazon, the Amazon logo, AmazonSupply, and the AmazonSupply logo are trademarks of Amazon.com, Inc. or its affiliates. As an Amazon Associate we earn affiliate commissions from qualifying purchases.