Chapter P7, Problem 1KC

To determine

Impact of transferring $1,000 from checking account to savings account on M1 and M2.

Answer to Problem 1KC

Option 'd' is correct.

Explanation of Solution

The money supply in the economy is calculated on the basis of various heads used to calculate the supply of money. The method that includes only cash in hand and the checkable deposits in the economy to measure the money supply is known as the M1 money supply. The measure of M2 money supply is more broader than the M1 as it includes all the components of the M1 as well as the components of the near money. The near money includes the savings deposits, money market securities, mutual funds as well as the time deposits in the economy.

Option (d):

The M1 measure of money supply is calculated by summating the cash in hand and the checking accounts. Hence, when the transfer of $1,000 from the checking account to savings account takes place, it reduces the M1 money supply by $1,000 because the savings account is not included in the M1 measure. The M2 remains unchanged because the decrease in checking account is equally credited in the savings account and there is no total change in the amount of M2. This means that the option 'd' is correct.

Option (a):

The M2 remains unchanged because the decrease in checking account is equally credited in the savings account and there is no total change in the amount of M2, but since the M1 only includes the cash in hand and the checking account, the reduction in checking account decreases the M1. This makes option 'a' incorrect.

Option (b):

Since the only two components of the M1 money supply are the cash in hand and the checking account, the reduction of $1,000 from the checking account will reduce the M1 by $1,000. But since the checking account and the savings account are the components of the M2 money supply, the decrease in checking account will equally increase the savings account that keeps the total sum unchanged and thus the M2 remains unchanged. This means that the option 'b' is incorrect.

Option (c):

Since the only two components of the M1 money supply are the cash in hand and the checking account, the reduction of $1,000 from the checking account will reduce the M1 by $1,000. The M2 remains unchanged because the decrease in checking account is equally credited in the savings account and there is no total change in the amount of M2.  This means that the option 'c' is also incorrect.

Economics Concept Introduction

M1 money supply: The M1 money supply is the calculation of money supply that includes only the cash and the checking deposits.

M2 money supply: The M2 is the calculation of the money supply that includes all the elements of the M1 money supply as well as the near money that includes the savings accounts, money market securities, time deposits and so on.