Question

Below, you are provided with values of several perfectly or near-perfectly liquid assets (before the transactions described below take place). Asset Value Savings Deposits $170 million Money Market Mutual Funds $40 million Travelers' Checks $5 million Currency and Coins $25 million Time Deposits $30 million Checking Deposits $240 million Suppose that households, on average, take $45 million out of their savings account balances and deposit those funds into their checking accounts. You will analyze the effect of these transactions on M1 and M2 in this assignment. Make sure to address the following issues/questions in your response: 1) Describe which of the two definitions of money (M1 or M2) is a stricter definition of money and why; 2) Calculate the value of M1 before and after the transactions described above; 3) Calculate the value of M2 before and after the transactions described above; 4) Identify whether M1 has grown, shrunk, or neither; and 5) Identify whether M2 has grown, shrunk, or neither.

Answer 1

Question 1

M1 includes currency and coins, checking deposits, and travelers' checks.

M2 includes currency and coins, checking deposits, travelers' checks, savings deposits, time deposits, and money market mutual funds.

It can be seen that components of M1 are more liquid than the components of the M2 in cumulative manner.

Due to this more liquid aspect, M1 is the stricter definition of money.

Question 2

Calculate M1 -

M1 = Currency and coins + Travelers' checks + Checking deposits

M1 = $25 million + $5 million + $240 million

M1 = $270 million

The M1 before transaction is $270 million.

Now, households has withdrawn $45 million from savings account and deposited into the checking account.

So, checking account balances will now increase to $285 million while savings account balances will decrease to $125 million.

Calculate M1 -

M1 = Currency and coins + Travelers' checks + Checking deposits

M1 = $25 million + $5 million + $285 million

M1 = $315 million

The M1 after transaction is $315 million.

Question 3

Calculate M2 -

M2 = Currency and coins + Travelers' checks + Checking deposits + savings deposits + Time deposits + Money market mutual funds

M2 = $25 million + $5 million + $240 million + $170 million + $30 million + $40 million

M2 = $510 million

The M2 before transaction is $510 million.

Now, households has withdrawn $45 million from savings account and deposited into the checking account.

So, checking account balances will now increase to $285 million while savings account balances will decrease to $125 million.

Calculate M2 -

M2 = Currency and coins + Travelers' checks + Checking deposits + savings deposits + Time deposits + Money market mutual funds

M2 = $25 million + $5 million + $285 million + $125 million + $30 million + $40 million

M2 = $510 million

The M2 after transaction is $510 million.

Question 4

The M1 has increased from $270 million to $315 million after the transaction.

So,

The M1 has grown.

Question 5

There is no change in value of the M2 after the transaction.

So,

The M2 has neither grown nor shrunk.