1) Overview — Money vs. Income vs. Wealth
Updated September 3, 2026 • Latest monthly money data: July 2026 • Latest velocity: Q2 2026
- Money = what you use to pay (means of exchange), a common unit of account, and an (imperfect) store of value.
- Income = earnings per period; Wealth = what you own (assets – liabilities).
- Payment tools versus money: a debit card accesses your deposit; a credit card lets you borrow. Your credit limit is not a money balance. A phone payment can simply move existing bank deposits.
- There isn’t one “correct” money measure. We use aggregates from narrow (most spendable) to broad (includes savings-type items).
2) Definitions — What is in M0/MB, M1, M2, M3?
| Component | M0 | MB | M1 | M2 | M3* |
|---|---|---|---|---|---|
| Notes & coins held by the public (excluding bank vault cash) | ✔ | ✔ | ✔ | ✔ | ✔ |
| Vault cash at banks | — | ✔ | — | — | — |
| Reserve balances at the Fed | — | ✔ | — | — | — |
| Demand & other checkable deposits (OCDs) | — | — | ✔ | ✔ | ✔ |
| Savings deposits added to M1 post-2020 | — | — | ✔ | ✔ | ✔ |
| Small time deposits (<$100k) | — | — | — | ✔ | ✔ |
| Retail money market funds (MMFs) | — | — | — | ✔ | ✔ |
| Large time deposits, institutional MMFs, short-term repos (other large liquid) | — | — | — | — | ✔ |
Definition notes: the Fed’s currency-in-circulation measure includes vault cash; the currency component of M1 excludes it. Current M2 also applies IRA/Keogh exclusions. Savings are already in current M1—do not add them twice. Fed H.6 definitions · M3 discontinuation
3) “Does the Fed control M1/M2/M3?”
Short answer
No, not directly. The Fed controls policy tools (interest rates, QE/QT, reserve terms). People and banks decide where to hold money and how much to borrow/lend. Those choices determine the aggregates, with lags.
Connect to student life
- Rates down → loans cheaper (student/auto) → more borrowing/spending → deposits can rise → M1/M2 often up.
- Rates up can slow lending and change where people save. A move into a retail MMF does not by itself imply lower M2: retail MMFs are included. The final effect depends on transactions across the banking system.
3b) How Are Money Supply and Monetary Policy Related?
First, separate five things students often mix up
| Concept | What does it mean? | Simple question |
|---|---|---|
| M1 / M2 | Measures of money: currency, deposits, and selected liquid instruments. | How much spendable or liquid money is held? |
| Monetary base | Currency in circulation plus banks’ reserve balances at the Fed. | How much central-bank money is there? |
| Policy interest rate | The Fed’s target for an overnight market interest rate. | How expensive is short-term funding? |
| The Fed’s securities holdings | Treasury and agency securities the Fed owns as assets. | How many bonds does the Fed hold? |
| Federal debt | Outstanding borrowing owed by the U.S. government. | How much does the government owe? |
What does a rate hike actually mean?
Hypothetical example: raising the target range from 4.00–4.25% to 4.25–4.50% is a 25-basis-point hike. Each endpoint rises 0.25 percentage point. This is an example, not a statement of today’s target.
- The Fed raises its policy target. Administered rates, particularly interest on reserve balances (IORB), help move overnight market rates toward that target.
- Financing conditions adjust. New and variable-rate borrowing can become more expensive. Some deposit yields rise too, though not immediately or equally.
- People and businesses respond. Some postpone a car, house, or equipment purchase; some prefer saving. Firms may reduce expansion and hiring.
- Demand and inflation pressure may ease over time. The timing and size of the effects are uncertain; the Fed does not set every consumer interest rate.
Implementation: The Fed Explained · IORB explanation.
How can this affect M1 and M2?
New bank loans can create deposits. If higher rates discourage new loans while borrowers repay existing bank loans, deposit growth can slow or balances can fall.
But households can also rearrange their balances. Checking to savings leaves current M1/M2 unchanged; savings to a small CD lowers M1 while leaving M2 unchanged in the simple example.
Must M2 fall after every hike?
No. The net result depends on new lending, repayments, government transactions, and portfolio choices. M2 can rise more slowly, fall, or keep rising.
A hike does not deduct 0.25% from your checking account. It changes interest-rate incentives. A $1,000 balance remains $1,000 unless a separate transaction changes it.
Rate hikes and QT: two different tools
| Tool | What changes directly? | How can it affect the economy? |
|---|---|---|
| Rate hike | The policy target and related administered rates. | Raises short-term financing costs; affects lending, saving, and spending. |
| QT — quantitative tightening | The Fed’s securities holdings decline, commonly as maturing principal is not fully reinvested. | Reduces the Fed’s balance sheet and can put upward pressure on longer-term yields relative to otherwise. |
QT does not mean the Fed must sell every bond. A maturing security can simply run off. Also, a $100 reduction in Fed assets does not imply a $100 reduction in M2: reserve balances, reverse repos, Treasury cash, and private deposits are different accounts.
Background: Fed analysis of balance-sheet reduction.
“If there was QT in 2022–2025, why did government debt keep rising?”
M0, M1 & M2 Explained: Why Did Government Debt Rise During QT?
What do M0, M1, and M2 include? See why the Fed can hold fewer Treasury securities while total government debt rises, using the refinancing and deficit example below.
Monetary policy is set by the Fed. Fiscal policy involves federal spending and taxes, set through Congress and the administration. When spending exceeds revenue, the government generally borrows to finance the deficit. That can add to outstanding debt while the Fed is reducing its holdings. Treasury: deficits · Treasury: debt.
A simple example: fewer bonds at the Fed, more debt overall
Illustration only; all amounts are billions. Ignore changes in Treasury cash and other financing adjustments. The Fed lets $100 of Treasuries mature. Treasury issues $250 to other investors: $100 replaces the maturing debt and $150 finances a new deficit.
| Treasury debt ownership | Before | Change | After |
|---|---|---|---|
| Held by the Fed | $200 | −$100 | $100 |
| Held by everyone else | $800 | +$250 | $1,050 |
| Total outstanding debt | $1,000 | +$150 | $1,150 |
What happened? The Fed’s Treasury holdings fell by $100, but government debt rose by $150. Refinancing the old $100 replaced one obligation with another; the additional deficit created the net increase. QT changed how much debt the Fed held, while the budget determined the new financing need.
Did QT actually shrink the Fed’s holdings in 2022–2025?
Yes. Runoff began in June 2022 and ended starting December 1, 2025. The Fed reported a decline of more than $2.2 trillion in its securities holdings, including about $1.6 trillion of Treasuries and $600 billion of agency mortgage-backed securities. Those are changes in the Fed’s assets, not a $2.2 trillion repayment of total federal debt.
Fed policy-normalization summary. Historical episode; checked September 3, 2026.
Can higher rates make government debt rise faster?
They can increase interest expense as new debt is issued and older debt is refinanced at higher yields. Unless other spending falls or revenue rises enough to offset that expense, borrowing needs can increase. Existing fixed-rate debt does not all reset immediately.
Can Higher Interest Rates Make Government Debt Rise Faster?
See how refinancing at a higher rate can increase interest expense, the budget deficit, and borrowing—and why existing fixed-rate debt does not reset immediately.
Why Is M2 Rising Again? Inflation and the National Debt Explained
Is M2 really rising at 6.8% this year? Learn the difference between the actual increase, the annualized pace, and year-over-year growth—then see how M2 can affect inflation and why it does not automatically create federal debt.
Key measurement: M2 increased 3.9% from December 2025 through July 2026. That equals an annualized pace of about 6.7%—roughly 6.8%—while July-to-July growth was 5.4%.
Class discussion: “M2 rose and federal debt rose, so tightening must have failed.” Is that enough evidence?
No. Identify what the policy changed directly, then examine borrowing conditions, demand, inflation, and timing. Money growth can be weaker than it would otherwise have been even when its level rises. Federal debt also reflects fiscal decisions. Two rising balances alone cannot establish whether monetary policy worked.
4) Why did M1/M2 change so much in the last decade?
From the pandemic to the latest data
- May 2020 definition change: savings entered M1, creating a large break in the series. The reclassification itself did not increase M2. Fed explanation.
- Pandemic + policy (’20–’21): transfers + bank lending ↑ deposits ⇒ M1/M2 up.
- 2022–23 reversal: M2 declined after its pandemic expansion as monetary conditions tightened. This is a historical episode, not a rule that every hike reduces M2. St. Louis Fed explanation.
Plain-English link
Policy → price of money (rates) → household/bank choices → deposits move → aggregates move. The Fed moves tools; people and banks move the aggregates.
Latest snapshot: July 2026 M2 was $23.218 trillion, up about 5.4% from July 2025. M1 was $19.886 trillion. This shows why the old “M2 is falling” description needs a date. M2 · M1
5) Practice — Money Supply Game
Play this quick sim, then answer the homework below.
Play the Game5b) Interactive — Student Activities & Money Supply
Click a student activity on the left. Then press Show explanation to reveal a detailed breakdown for both the current (post-2020) and classic (pre-2020) definitions.
Student Activity
Result (Arrows use Current M1)
MB
M1
M2
Post-2020 (Current M1 = C + D + S)
- MB:
- M1:
- M2:
- Why:
| Component | Δ | Explanation |
|---|
Pre-2020 (Classic M1 = C + D)
- M1 (classic):
- M2 (both eras):
- Why:
| Component | Δ | Explanation |
|---|
6) Watch — Khan Academy: Money aggregates
Tip: open the FRED charts below while you watch.
7) Updated Charts — How Much Money Is There?
Verified September 3, 2026. Monthly snapshot: July 2026, released August 25. M1/M2 and public currency are seasonally adjusted; the monetary base is not. Dollar amounts below are trillions.
M1: $19.886 trillion
Monthly snapshot from FRED M1SL. Vertical axis: trillions of dollars.
M2: $23.218 trillion
Monthly snapshot from FRED M2SL. Vertical axis: trillions of dollars.
Longer history: see the pandemic break and later changes
These saved FRED charts were retrieved September 3, 2026 and show history from 2015. Open on FRED for the latest interactive version. The saved charts remain visible offline.
Public currency (M0 proxy)
Open on FRED ↗Notes and coins outside Treasury, the Fed, and bank vaults. July 2026: $2.383 trillion. “M0” is classroom shorthand here.
Monetary base (MB)
Open on FRED ↗Currency in circulation, including vault cash, plus reserve balances. July 2026: $5.524 trillion. Bank reserves are not household deposits.
M1: watch the May 2020 break
Open on FRED ↗Current M1 includes public currency, checking, and savings. The 2020 jump partly reflects a changed definition.
M2: broader liquid money
Open on FRED ↗Current M2 adds small time deposits and retail MMFs to M1, with retirement-account exclusions. Savings are already inside M1.
What happened to the old M3 chart?
The Federal Reserve stopped publishing M3 in March 2006. The old chart used an OECD series, not an IMF estimate. Its last observation is November 2023; do not treat it as current U.S. M3 or compare it mechanically with the historical Fed definition.
Historical OECD series Fed discontinuation notice8) Velocity of Money — How Actively Is Money Used?
Money supply asks “How much money exists?” Velocity asks “How much final-goods-and-services spending does that money support?” A large bank balance can sit idle or support repeated purchases.
A $20 classroom example
You pay $20 for a haircut. The barber spends that $20 on a meal. The restaurant owner spends it on a new book. In this simplified economy, three purchases of newly produced final goods and services total $60, supported by the same $20: velocity = $60 ÷ $20 = 3 during the period. No extra $20 bill was needed. Real GDP-based velocity is an aggregate ratio, not a count of every bank transfer or stock trade.
The formula
V = nominal GDP ÷ M2
Equivalently, M × V = P × Y. M is the money stock, V is velocity, P is the price level, and Y is real output. P × Y is nominal GDP.
For illustration, $30 trillion of annual GDP ÷ $20 trillion of money gives V = 1.5.
How to read FRED
FRED M2V uses annualized quarterly nominal GDP divided by quarterly average M2. Thus 1.415 means about $1.415 of annualized GDP per $1 of M2, not 1.415 purchases per quarter.
Use matching periods. Do not divide quarterly GDP by a single month’s M2. M2V methodology · GDP units
Watch — Velocity of Money
Explore velocity, inflation, interest rates, national debt, and international comparisons.
As you watch: Why does faster spending not always raise prices? Why does creating money not automatically pay off government debt?
FRED data: the pandemic drop and recovery
M2 velocity, quarterly, seasonally adjusted; annualized ratio. Saved data: Q1 2015–Q2 2026. Dashed line: average of the four quarters of 2019.
Source: Federal Reserve Bank of St. Louis, FRED M2V observations, checked September 3, 2026. Data may be revised. This saved graph and comparison remain readable offline.
View the original FRED graph and longer history
Open longer history on FRED, starting in 1990 ↗
The saved FRED image covers 2015 onward; follow the link for a longer view and newer releases.
Now versus a “normal” economy
Use 2019 as a practical pre-pandemic benchmark, not an ideal target. Velocity changes with saving preferences, interest rates, financial products, and money demand. A higher reading is not automatically healthier.
| Period | M2 velocity | Student interpretation |
|---|---|---|
| 2019 average | 1.449 | Reference before the pandemic disruption; average of four quarterly readings. |
| 2019 Q4 | 1.435 | Last full pre-pandemic quarter. |
| 2020 Q2 | 1.126 | Nominal activity fell while M2 expanded sharply. |
| 2026 Q2 — latest | 1.415 | About 25.7% above 2020 Q2, 2.4% below the 2019 average, and 1.4% below 2019 Q4. |
Interpretation: GDP per dollar of M2 has recovered substantially toward its pre-pandemic level. This ratio alone cannot establish that inflation, jobs, or the whole economy are “normal.”
Why does velocity change?
- Holding more cash: uncertainty can encourage larger balances relative to spending, lowering V.
- Spending recovers: if nominal GDP grows faster than M2, V rises.
- Prices versus production: nominal GDP can rise through higher prices, higher real output, or both. Rising V does not necessarily mean more physical goods were sold.
- The denominator matters: slower M2 growth or a decline in M2 can lift V even without booming spending.
Try it: does extra spending buy more goods or raise prices?
Illustrative annual economy with $100 of money. Choose what stays fixed, then change velocity. These are two possible adjustments—not forecasts.
Price stays at $1. Output adjusts to spending; assume producers can supply the quantity demanded.
$100 × 1.5 = $1.00 × 150
With price fixed, output changes. With output fixed, price changes. Real economies often adjust through both. M × V = P × Y is an identity; by itself, it does not establish which variable causes another to change.
Why does the price fall when velocity falls? Is that deflation?
Yes—in this simplified model, if money and real output stay fixed. Use M × V = P × Y, or P = (M × V) ÷ Y.
| Variable | Before | After |
|---|---|---|
| Money supply (M) | $100 | $100 |
| Velocity (V) | 1 | 0.5 |
| Real output (Y) | 100 units | 100 units |
| Nominal spending (M × V) | $100 | $50 |
| Price per unit (P) | $1.00 | $0.50 |
If the same 100 units are still produced and sold, $50 of spending implies an average price of $0.50 per unit. The model’s price level has fallen 50%. A decline in the economy’s general price level is called deflation; one product going on sale is not enough to establish economy-wide deflation.
Actual prices would not automatically fall by half. Businesses might sell less, reduce production, or cut employment instead. Money supply could also change. Holding M and Y fixed in the “Same output” mode illustrates one possible adjustment, not exactly what the economy will do. In the “Same price” mode, lower velocity instead reduces output sold while the price remains $1.
Low velocity is not the same as continuing deflation. In the example, prices fall when velocity drops from 1 to 0.5. If velocity then stays at 0.5 and M and Y remain unchanged, the price stays at $0.50; it does not keep falling.
This comparison starts at V = 1. In “Same output” mode, V = 1.5 gives a model price of $1.50. Moving from 1.5 to 0.5 in that mode lowers the model price from $1.50 to $0.50—a 66.7% decline. The percentage change depends on the starting value.
Check your understanding: if M2 rises 10% and velocity falls 10%, must spending rise?
No. 1.10 × 0.90 = 0.99, so nominal spending falls 1% in this example. Money growth alone does not determine spending.
9) Practice Quizzes — True / False
3 quizzes • 10 questions each • Instant feedback
Open a quiz and choose True or False. Each answer gives an immediate explanation, just like the FIN301 quizzes. Each quiz has five true and five false statements.
Quiz 1 — Money Supply — M1, M2 & Bank Deposits
True/False with instant feedback. Select an answer to see an explanation.
Quiz 2 — Monetary Policy — Rate Hikes, QT & Federal Debt
True/False with instant feedback. Select an answer to see an explanation.
Quiz 3 — Velocity of Money — Spending, Inflation & Interpretation
True/False with instant feedback. Select an answer to see an explanation.
10) Homework — Rate Hikes and M2
Background: In his Friday, August 28, 2026 speech, Fed Chair Kevin Warsh emphasized that money matters for monetary policy and that inflation remained too high. Read the speech.
In ≤250 words: Suppose the Fed raises interest rates to help reduce inflation. Explain the connection to M2 money supply in simple terms:
- What is M2? Give two examples of money included in it.
- How could higher interest rates affect bank borrowing, the creation of new deposits, and spending?
- Must M2 fall after a rate hike, or could it keep rising? Explain briefly and include one student-life example, such as borrowing to buy a car or paying for a purchase with a credit card.
Use your own words. No calculations are required. The rate hike is a hypothetical scenario, not a confirmed decision from the speech.
11) Student Questions & Answers
66 questions • Searchable • Click to reveal answersHave a question? Search by keyword or choose a topic. Select a student question to open its course explanation.
1. What is money?
2. What are the three main functions of money?
3. How is money different from income?
4. How is money different from wealth?
5. Why is barter inconvenient?
6. Is a debit card itself money?
7. Is my credit-card limit part of my money supply?
8. Are stocks and bonds money?
9. Does money have to be paper cash?
10. If prices double and my cash stays the same, am I just as well off?
11. Why do economists use several measures of money?
12. What does M0 mean in this lesson?
13. What is the monetary base, or MB?
14. Are bank reserves the same as my checking-account balance?
15. What is in current M1?
16. What does M2 add to M1?
17. Are savings accounts part of M1 or only M2?
18. Why did M1 jump sharply in 2020?
19. Is a money market deposit account the same as a money market fund?
20. Why is the old M3 chart no longer a current-money chart?
21. Can a commercial bank create money when it makes a loan?
22. Why can banks not make unlimited loans?
23. What happens when I withdraw $50 from checking at an ATM?
24. What happens when I deposit $100 of cash into checking?
25. Does moving checking money into savings reduce current M1?
26. What happens if I move $400 from savings into a small CD?
27. Does buying shoes with a debit card destroy money?
28. Does paying back a bank loan reduce deposit money?
29. Does moving money into a retail money market fund necessarily shrink M2?
30. Does the Fed directly choose the exact dollar amount of M2?
31. What is the velocity of money?
32. What is the formula for M2 velocity?
33. What does M × V = P × Y mean?
34. Can velocity change while M2 stays unchanged?
35. If money is $100 and annual nominal GDP is $150, what is velocity?
36. Does FRED’s quarterly velocity number mean turns per quarter?
37. Why did velocity fall during the pandemic?
38. Why can velocity rise even without a spending boom?
39. Why use M2 velocity for a comparison across 2020?
40. Does every stock trade or bank transfer count in GDP-based velocity?
41. What is the latest velocity reading in this lesson?
42. How does that compare with the pre-pandemic economy?
43. Is there one normal velocity that the economy should reach?
44. Does velocity near its 2019 level prove the economy is healthy?
45. Does a 10% increase in money guarantee 10% inflation?
46. What if money rises 10% while velocity falls 10%?
47. Does higher velocity always mean people bought more goods?
48. Can people spend more without the money supply increasing?
49. Why do the money charts and velocity chart have different latest dates?
50. What should I check before interpreting a FRED money graph?
51. Are M1/M2 and monetary policy related?
52. What does a 25-basis-point rate hike mean?
53. Does a hike remove money from my checking account?
54. How does a rate hike affect lending and money creation?
55. Must M1 and M2 fall whenever the Fed raises rates?
56. Are rate hikes and QT the same thing?
57. Does QT require the Fed to sell its bonds?
58. Does a $100 decline in Fed assets mean M2 falls $100?
59. Whose debt is a Treasury bond, and whose asset is it?
60. Why could federal debt rise during QT in 2022–2025?
61. What is the difference between a deficit and debt?
62. If Treasury repays a bond held by the Fed, why might total debt not fall?
63. Did the Fed’s holdings actually fall during the 2022–2025 QT episode?
64. Can higher interest rates increase the government’s borrowing needs?
65. Does rising federal debt prove monetary tightening failed?
66. If M2 increases, shouldn’t government debt fall? Why can both rise?
No—an increase in M2 does not automatically repay government debt. M2 measures money balances, including currency, deposits, and certain liquid savings. Federal debt measures what the government owes. They are different quantities, not opposite sides of a fixed total.
Example 1: a bank loan. A bank lends you $1,000 and credits your checking account. M2 rises by $1,000 in this simplified transaction, but no Treasury bond has been repaid. Federal debt is unchanged; you now owe a private bank loan.
Example 2: a Fed bond purchase. When the Fed buys an existing Treasury bond from a nonbank investor, the transaction can increase deposits. The Treasury still owes the bond; the Fed now owns it. The purchase changes ownership and does not cancel the government’s obligation.
Why can debt keep rising? If federal spending exceeds revenue, financing the deficit generally requires additional borrowing. More money in the economy does not by itself eliminate that financing need. M2 and federal debt can therefore rise together.
Definition and data references: Fed H.6 · 2020 definition change · FRED velocity data. Fed QT history · Treasury debt guide. Current-data answers use the September 3, 2026 lesson snapshot.