Money supply: M0, M1, and M2 | The monetary system | Macroeconomics | Khan Academy
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Money supply: M0, M1, and M2 | The monetary system | Macroeconomics | Khan Academy


What I want to explore
in this video is the different ways of
measuring the amount of money we have in circulation. So we’re going to start
things with our Central Bank in the US. This would be the
US Federal Reserve. And let’s say that
they print $4. And we’re going to focus, just
for visualization purposes, on that they’re
doing it physically. They could also do
it electronically. But we’re just going to
focus on the physical. And the way that they
get this into circulation is it they’ll take
these $4 and they’ll go buy securities in the
open market, normally very safe and very
liquid securities. Liquid means it’s very
easy to buy and sell those securities in
large quantities. For example,
government treasuries is a liquid security,
or liquid asset. PEZ dispensers would
not be a liquid asset. If I bought a billion
dollars worth of PEZ dispensers it would be very
hard for me to sell– one it would be very hard for me
to buy a billion dollars worth. And it would be even
probably even harder for me to sell a billion dollars
worth in any short or medium timeframe. So the Central Bank goes out,
and let’s say they go and buy one liquid security for $4. So this is a security
right over here. And the person that they
bought the security from decides to deposit it in a bank. They could either directly
deposit it in a bank or they could use
that money that they got from selling their
security to buy things, and the person they
bought things from could deposit it in a bank. But one way or another we
can imagine it all gets deposited in a bank. So this is our private bank. I’ll call this private
bank number one. So now all of these
dollars are transferred to private bank number one. And they are no longer–
the Federal Reserve, or the Central Bank,
in the general case, is no longer in
possession of them. They’ve been transferred
right over here. And I want to cross
these out just so we can keep track of things. Now when they deposit it
in private bank number one, they said, well, I need three
of these dollars on demand. And I want to write
checks against them. So they put three of these
dollars in a checking account. There are at three of these
dollars a checking account. So checks up too– so
write checks up to $3. And so they can get a
little bit more interest, and the bank’s willing to give
a little bit more interest on a savings account
because they don’t have to keep the reserves, they
put $1 into a savings account. And they cannot write checks
against that savings account. Now there are special
circumstances now, but for simplicity, let’s just
say that they cannot write checks. There are some that have
restricted check writing and things like that now. So this bank says, OK,
well, this dollar, I don’t have to even have
any reserves against it. I could loan out this dollar. And the person they
lend it to, let’s say that they immediately go and
deposit it into another bank. So they immediately go and
deposit this in private bank, I’ll call this private bank two. So it’s no longer
in private bank one. Let me draw a private bank two. Private bank two is
a right over here. Private bank number two. And they deposit it
into a savings account in private bank number two. And let’s say all of
this, out of all of this, the bank says, well,
this is a demand deposit, I have to keep some reserves. This is a fractional
reserve system. But I can lend out, in the
US, I could lend out up to 90% of this. And maybe this bank is a
little bit more conservative, They only lend out 2/3 of this. So they lend out
$2 out of these $3 And let’s say the person
they let it do also happens to deposit it
in private bank number two, just coincidentally. So these two also end up
in private bank number two. And so they’re no longer
in private bank number one, although this person could
still write checks up to $3. And now here in
private bank number two– and let’s say
these are deposited in a checking account. These are deposited right over
here in a checking account. Now private bank number two,
it can do a couple of things. In this checking account it
has to keep some reserves. Let’s say it’s even
more conservative. It only decides to
lend out half of this, even though it
could lend out 90%. And so it lends out
one of these dollars. And the person that they lend
it to just takes that dollar and they put it in their wallet. So they just put
it in their wallet. And they could also lend
out this entire savings. And let’s just say
that the person that they lend that
$1 in savings to also puts it in their wallet. And notice, the original
$4 are still there. One, two, three, four. Now, and just to be clear,
this person right over here can write checks up to $3 . And this person
right over here can write checks– let me do
that same checking account color– they can
write checks up to $2. Now let’s think about the
different forms of money there are here. Well, we could think of money in
a very, very narrow way, which is just what did the Central
Bank print, or create electronically as electronic
reserves of its member banks? But for simplicity
here you can just think about the physical
currency that it printed, its base money. And so that, often, is just
referred to as base money. And in the US and
other countries it’s often the same thing as M0. There’s slight differences
from country to country. And in this example, as soon
as they printed it and put it into circulation, that was $4. We had $4 of base money. And that’s obvious because
as soon as they printed this and they bought the
security with it, and it was in circulation, that
$4 could be used to buy things. It could be used to
facilitate transactions. Now that clearly isn’t
all of the stuff that can be used as money in this
little universe we created. This guy, you have the
$4 but these people can also write checks
right over here. And so we can have a slightly
broader definition of money. And over here, we
will call it M1. And here, there’s a couple of
ways you could think about it. You could think about it as
all of the currency that’s in people’s pockets plus all of
the check writing capabilities. So if you view it
that way it, would be this $2 plus $5 of
check writing capabilities right over here. So you could have $2
of physical currency that’s in people’s wallets,
not in bank reserves, plus the $5 of check
writing capability, which would give you $7. Another way you
could view it, you could view it as M0
plus checkable deposits. I’ll just write checks
here, plus– well I’ll write– checkable deposits. But if you do that,
you are now double counting because
some of the M0 is reserves in the
checkable deposits. Or you could say some of
the checkable deposits is held as reserves for M0. So then you would have to
subtract out the bank reserves. And so then you would
get $4 because we don’t want to double count
these right over here. You would get M0 is $4. And I want to do that in white. M0 is $4. The checkable deposits is $5. Let me do that in the pink. Plus the $5. And then you would want to
subtract out the reserves. And the reserves here, there
are $2 of the reserves. So minus $2. And you would get
yourself back to the $7. And the whole point of this is
so you’re not double counting something, you’re not double
counting this right over here, as part of checkable
deposits and part of the M0. You’re not using this twice. It’s not part of the base money. It is both the base money
and checkable deposits. And we don’t want
to count it twice. So the simplest
way to think about is, well, what can be used
in this broader definition to facilitate transactions? These $2 in people’s
pockets, and this ability to write up to $5 of checks. So that’s this view
right over here. And if we want to get
even broader than that, we can get to
something called M2. And here we could say,
OK, what’s immediately usable to facilitate a
transaction right now? So that would be our M1. So that would be our $7 of M1. Plus things that can be
easily converted to M1. So for example, these
savings accounts can be easily converted
to checking accounts. It might only take
a couple of days. There might be
some restrictions. But it can be converted. And when it gets converted
will change the bank’s reserve requirements a little bit. But it will allow, if
this person converts it they will have the ability
to write more checks. So M2 includes M1
plus things that are very easy to convert to M1. And so they’ll include things
like savings accounts, money market accounts, which I
won’t go into detail here. But they’re really kind
of similar in that you get slightly higher
interest, but there are restrictions on your
ability to access it. But it’s not too hard to turn
it into checking accounts. And small dollar value
time deposit, CD accounts. But for the sake of
simplicity, in this example, it would be the saving accounts. So it would be our
$7 of M1, plus the $2 of savings accounts
right over here. So this is just to
give you a picture. When someone talks
about the money supply you really
have to say, well, what are you talking about? The most typical one is that
you’re really talking about M1, because this is the stuff that’s
directly usable to facilitate transactions. Things like the ability
to write a check, or dollar bills in
someone’s wallet. But they might be talking about
base money, M0, narrow money, always of referring
to the same thing, especially in the United States. Or they might be referring
to something even broader. And there are
broader definitions even than M2,
although M3, they’ve stopped reporting about it. But M3 would have things
that are a little bit further from being true money, from
being a checking account. But they are already
fairly liquid and so they’ll include
other types of assets. But the Fed has
stopped reporting this in the recent past. So these are the ones that
are typically referred to.

About James Carlton

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70 thoughts on “Money supply: M0, M1, and M2 | The monetary system | Macroeconomics | Khan Academy

  1. I have trying to grasp and understand the M's for a while now … this is simply put and very well explained … Thank you very much, your videos are just perfect

  2. So, out of curiosity, where does the money to pay of the interest from the first private bank deposit come from?

  3. So then this begs the question the, if we are ultimately creating a debt that must be repaid with a non-money source, why have money? Seems like we could save a good chunk of energy by not even worrying about it.

  4. Safe assets to save your money in is scarce materials like gold, silver, copper etc. Buy those.

    Anyways, I love khanacademy!

  5. hey you should apply for youtube partnership if you haven't already, that way you get paid a good amount of money by teaching 😀

  6. What about the 3 dollars that the system creates out of thin air? I assume that it is for making the money circulate more easily, but the question is: What backs up these 3 extra dollars from M2, as the 4 dollars from the central Bank had securities that backed them up?

  7. Absolutely nothing, which is one of the main critics to the fractional reserve banking system. As strange as it may sound, the power of increasing and decreasing the money supply in the economy is in the hands of Private Banks

  8. I agree, and what a scary and sad scenario! I think that it can be extrapolated to the global scenario and say that Private Banks control the global money supply. Thus, the world "monetary" economy? …There's definitely something wrong in the world!

  9. So what your saying in the video is that QE3 promise of $40 billion a month is more like $70 billion when it gets into our economy using M1 money supply. Very interesting… thanks for helping to figure out screwed our dollar has become from the FEDS. God bless America!!!

  10. So it seems the security that the central bank bought from the private bank is pretty valuable. How did the private bank come into possession of this security? Who did they buy it from? Or did they (private bank) create this security to begin with? and why couldn't just the private bank use the value of that security to divide it up into checking and savings accounts and lend it out themselves without having to sell it to a central bank? It seems the real creators of money is private bank right?

  11. Yo, have you considered this plan called the Intellitus Cash System? (do a google search). My coworker says it earns people plenty of money.

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  13. There is fallacy in your reasoning:
    1.Money has no intrinsic value
    2.The value of money lies with its exchangeability for goods and services
    3.If any body other than State has a power to increase money supplies it is a theft
    4.Whoever increases the money supplies it gets goods and services for literally nothing.
    4.Any country can control its money supplies without borrowing money from anybody, because if anybody should be allowed to get goods and services for nothing it should be the State

  14. Okay, if you could PLEASE answer (I would greatly appreciate it) I have two questions.  1)  Is the money that the bank lends out actually in the form of hard cash?  Your demonstration would seem to indicate that such is the case, but I don't think it actually works that way (in which case the deposited reserves would still be held at PB A, meaning that they could actually loan out more than just a fraction of those deposits, but could rather loan out as much as possible to where the actual amount of reserves that they do still hold are equal to 10% of all credited deposits, which would be more than that shown in the example.  Am I wrong?  Please tell me if I am.

    and 2)  Are you saying there are no reserve requirements on savings accounts but only checking?  Or were you simply implying that there were still enough reserves left in the checking account to loan out the savings account without worrying about being in violation?

    Of course I'm sure these questions will be ignored…..sigh…..oh well…. What is a boy to do?  You know, I find I actually spend more time searching for the right sources for the right answers to my questions than I actually do studying said material (if and when I actually do find them), which is just frustrating to no end.  Reading/listening is easy.  Actually knowing what to read/listen to and where to find it (in order to find the actual answers you are looking for) is another story.

  15. Around 6:45, should you perhaps say "checkable reserves?"  I see a lot more "reserves" than just $2 worth, unless i misunderstand how you are defining "reserves."

  16. I absolutely hate the way you repeat yourself so much for the most irrelevant things 'private bank number 2' every fucking video. so annoying.

  17. Very confusing and bunch a nonsense. On a 1 to 10 reserve ratio banks can lend nine dollars for ever $1 they hold in reserves (deposits). The $reserve depends upon their total depositors. Depositors lend money to banks. Physical cash equates $1 to $1 bank reserves which is withdraw from a local bank. The central bank only ensures that banks cash other banks checks.

  18. This does ot explain the difference between the M0 and the amount of cash usd around the world. the M0 in 2005 was 800 billion but there is 1.35 paper money in total. it does not explain the difference between these two

  19. I am studying to take an economics test to teach the subject in Georgia and this video was very helpful in understanding this concept. thank you very much.

  20. at 7:13 when he is masuring checkable deposits dosen't he do doube counthing on one dolar of PB#2 which has been alrady counted as a one dolar in the pocked?

  21. watching you write and draw you little illustrations is rather painful. This video could be a 3 mins at most if you did that beforehand

  22. So that means Central Bank buys things with the money that they can print without doing anything. How exactly?

  23. Thanks for video:)
    I'v watched previous video but I still don't understand.
    Previous video says there's some money ON DEMAND,thus PB(Private Bank)can't loan out these money. So,how can PB can loan out money from checking account?
    (the money in this account is on demand. be able to withdraw at anytime)
    I know Fractional reserve banking,but that is the Money No.1 in the PB#1,am I right?

  24. Your video is flat out wrong. Our fractional reserve system does not mean they can loan out 90% of the depositor's money. In fact, it is illegal for them to loan money from "on demand deposits". You really should learn the system before trying to teach it. And, you should take down this video because you are teaching people the wrong thing. The way you have explained it would only expand the money supply through Federal Reserve market operations and that would not keep up with the growth in GDP or the desires for the people to "HAVE IT NOW". The "have now, pay later" is facilitated when Federal Reserve Member Banks create money out of thin air (the 'other 90%') when they receive a promissory note from a borrower. It's a double entry ledger. The promissory note goes on the credit column of the borrower's account and the money they created and gave the borrower goes on the debit side of the bank's capital account. At the end of each day, they are required to have at least 10% of their their capital account balance on deposit with the Federal Reserve. If they don't meet the requirement, they have to borrow enough cash to meet this 10% reserve. They can either borrow from the Fed or other member banks. The interest on these funds is what we call the "over night funds rate".

  25. Amazing video!!! TY SO MUCH!!! The only issue is right at the start with the Central Bank decided to buy a liquid security for $4. The question becomes how did the liquid security get there? Surely that person who bought the liquid security spent $4 in cash for it. So I would have wished the video started with that!

  26. Sorry but the FED does not print money, it only creates money through loans. The Treasury Department is the one that prints physical money (bills).

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