Though they look different depending on where you live, we’re all familiar with cash and coins.  So, we might initially decide to define money as simply cash and coin. 

But that seems naïve.  Most of us keep our “money” in the bank.  It’s both too dangerous and too inconvenient to carry it around with us all the time.  So, perhaps our checking account should be included?  Besides, with a debit card, it’s as spendable as cash.   

But then, what about the money we keep in our savings accounts and our money market accounts?  Isn’t this money also?  Of course, it is, but it’s not quite as spendable – Economists use the term “liquid” to mean how spendable.  And then there’s the “money” you have in Disney stock. But that’s not money.  The only way you could spend it would be to sell the stock to someone else and get their money to spend.  This is really confusing. 

Here’s what we’ll do.  We’ll come up with a couple of definitions of money.  The first will be made up of money we can all agree is very liquid (i.e. spendable).  Then we’ll broaden the definition a little to include “money” that’s less liquid.  And perhaps even broaden it again. 

So, here goes.  M1 is the most liquid type of money.  It’s made up of cash, coins, and the various types of accounts that allow unlimited checking access – mostly standard checking accounts. 

M2 will be a broader definition that includes all of this stuff, but we’ll also throw in your savings account, your money market account (they limit how many checks you can write and so not M1), and maybe some odd types of CDs that are really liquid. 

We could go on with M3, which includes all of this stuff plus other even less liquid ways of holding money.  But we’ll stop with just M1 and M2.  The following diagram represents the relationship between the two.  M1 is represented by the inner blue bubble.  While M2 includes the blue bubble, M1, plus some other things. 

Which is more relevant?  More or less, M2.  Computer have made it so easy to move money from less liquid forms to one’s checking account, the difference is mostly pointless.