Wednesday, January 12, 2011

A Closer Look At Money Supply; M2

Let's finish our look at the current situation with the money supply by focusing on M2, which is

A category within the money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds.

In other words, we're looking at a broader definition of money supply that includes less liquid forms of money, most importantly savings deposits. While these are still liquid -- that is, they are still available pretty quickly -- they are considered the "second line" of spending (people will spend these funds after spending more liquid funds).

Overall, the year over year percentage change in M2 is exceedingly low. In addition, it has dropped sharply after the spike at the end of the recession.

Remember that M2 includes M1. This chart shows that the non-M1 components of M2 are the reason for the drop.

The real reason for M2s drop is above: since money market funds are yielding next to nothing right now, people are pulling their money out of these funds.

Notice that savings deposits have increased strongly. This correlates with the increase in the savings rate the we've seen since the end of the recession.

Velocity has dropped, but a fair amount of that has been caused by the drop in money market funds.