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One of our goals is to determine how the money supply affects the economy. As a
background for that analysis, lets first discuss how economists measure the quantity
of money.
Because money is the stock of assets used for transactions, the quantity of money is
the quantity of those assets. In simple economies, this quantity is easy to measure. In
the POW camp, the quantity of money was the number of cigarettes in the camp. On
the island of Yap, the quantity of money was the number of fei on the island. But how
can we measure the quantity of money in more complex economies? The answer is not
obvious, because no single asset is used for all transactions. People can use various
assets, such as cash in their wallets or deposits in their checking accounts, to make
transactions, although some assets are more convenient to use than others.
The most obvious asset to include in the quantity of money is currency, the sum
of outstanding paper money and coins. Most daytoday transactions use
currency as the medium of exchange.
A second type of asset used for transactions is demand deposits, the funds
people hold in their checking accounts. If most sellers accept personal checks
or debit cards that access checking accounts balances, then assets in a
checking account are almost as convenient as currency. That is, the assets are
in a form that can easily facilitate a transaction. Demand deposits are
therefore added to currency when measuring the quantity of money.
Once we admit the logic of including demand deposits in the measured money
stock, many other assets become candidates for inclusion. Funds in savings
accounts, for example, can be easily transferred into checking accounts or
accessed by debit cards; these assets are almost as convenient for
transactions. Money market mutual funds allow investors to write checks
against their accounts, although restrictions sometimes apply with regard to
the size of the check or the number of checks written. Because these assets can
be easily used for transactions, they should arguably be included in the
quantity of money.
Because it is hard to judge which assets should be included in the money stock,
more than one measure is available. Table 41 presents the three measures of
the money stock that the Federal Reserve calculates for the U.S. economy,
together with a list of which assets are included in each measure. From the
smallest to the largest, they are designated C, M1, and M2. The most common
measures for studying the effects of money on the economy are M1 and M2.