Question

Problem 5. (8 points) Suppose you find $500 buried in your backyard and thus has been out of circulation. Explain what happens to M1 and M2 when you put $200 in your checking account, $200 in your money market mutual fund, and $100 in your savings account.

Answer 1

When $ 200 is deposited in the checking account then the M1 as well as M2 will increase by $ 200. M1 will increase by the amount deposited because it includes the checking account. Since, M2 includes both Checking as well as saving account.

When $200 of cash is deposited into a money market mutual fund. M2 will remain the same since both currency and money market mutual funds are included in M2. No change in M1 because the amount was out of circulation.

When $ 100 is deposited into saving account then the value of M2 will increase. There will be no impact on M1 because it does not includes saving account.