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What I want to explore
in this video is

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the different ways of
measuring the amount of money

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we have in circulation.

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So we're going to start
things with our Central

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Bank in the US.

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This would be the
US Federal Reserve.

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And let's say that
they print $4.

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And we're going to focus, just
for visualization purposes,

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on that they're
doing it physically.

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They could also do
it electronically.

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But we're just going to
focus on the physical.

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And the way that they
get this into circulation

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is it they'll take
these $4 and they'll

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go buy securities in the
open market, normally

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very safe and very
liquid securities.

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Liquid means it's very
easy to buy and sell

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those securities in
large quantities.

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For example,
government treasuries

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is a liquid security,
or liquid asset.

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PEZ dispensers would
not be a liquid asset.

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If I bought a billion
dollars worth of PEZ

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dispensers it would be very
hard for me to sell-- one

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it would be very hard for me
to buy a billion dollars worth.

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And it would be even
probably even harder

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for me to sell a billion dollars
worth in any short or medium

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timeframe.

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So the Central Bank goes out,
and let's say they go and buy

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one liquid security for $4.

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So this is a security
right over here.

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And the person that they
bought the security from

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decides to deposit it in a bank.

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They could either directly
deposit it in a bank

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or they could use
that money that they

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got from selling their
security to buy things,

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and the person they
bought things from

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could deposit it in a bank.

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But one way or another we
can imagine it all gets

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deposited in a bank.

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So this is our private bank.

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I'll call this private
bank number one.

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So now all of these
dollars are transferred

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to private bank number one.

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And they are no longer--
the Federal Reserve,

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or the Central Bank,
in the general case,

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is no longer in
possession of them.

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They've been transferred
right over here.

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And I want to cross
these out just

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so we can keep track of things.

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Now when they deposit it
in private bank number one,

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they said, well, I need three
of these dollars on demand.

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And I want to write
checks against them.

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So they put three of these
dollars in a checking account.

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There are at three of these
dollars a checking account.

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So checks up too-- so
write checks up to $3.

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And so they can get a
little bit more interest,

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and the bank's willing to give
a little bit more interest

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on a savings account
because they don't have

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to keep the reserves, they
put $1 into a savings account.

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And they cannot write checks
against that savings account.

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Now there are special
circumstances now,

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but for simplicity, let's just
say that they cannot write

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checks.

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There are some that have
restricted check writing

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and things like that now.

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So this bank says, OK,
well, this dollar, I

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don't have to even have
any reserves against it.

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I could loan out this dollar.

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And the person they
lend it to, let's

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say that they immediately go and
deposit it into another bank.

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So they immediately go and
deposit this in private bank,

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I'll call this private bank two.

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So it's no longer
in private bank one.

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Let me draw a private bank two.

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Private bank two is
a right over here.

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Private bank number two.

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And they deposit it
into a savings account

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in private bank number two.

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And let's say all of
this, out of all of this,

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the bank says, well,
this is a demand deposit,

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I have to keep some reserves.

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This is a fractional
reserve system.

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But I can lend out, in the
US, I could lend out up to 90%

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of this.

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And maybe this bank is a
little bit more conservative,

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They only lend out 2/3 of this.

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So they lend out
$2 out of these $3

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And let's say the person
they let it do also

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happens to deposit it
in private bank number

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two, just coincidentally.

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So these two also end up
in private bank number two.

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And so they're no longer
in private bank number

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one, although this person could
still write checks up to $3.

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And now here in
private bank number

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two-- and let's say
these are deposited

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in a checking account.

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These are deposited right over
here in a checking account.

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Now private bank number two,
it can do a couple of things.

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In this checking account it
has to keep some reserves.

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Let's say it's even
more conservative.

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It only decides to
lend out half of this,

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even though it
could lend out 90%.

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And so it lends out
one of these dollars.

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And the person that they lend
it to just takes that dollar

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and they put it in their wallet.

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So they just put
it in their wallet.

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And they could also lend
out this entire savings.

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And let's just say
that the person

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that they lend that
$1 in savings to also

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puts it in their wallet.

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And notice, the original
$4 are still there.

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One, two, three, four.

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Now, and just to be clear,
this person right over here can

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write checks up to $3 .

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And this person
right over here can

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write checks-- let me do
that same checking account

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color-- they can
write checks up to $2.

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Now let's think about the
different forms of money

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there are here.

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Well, we could think of money in
a very, very narrow way, which

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is just what did the Central
Bank print, or create

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electronically as electronic
reserves of its member banks?

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But for simplicity
here you can just

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think about the physical
currency that it printed,

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its base money.

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And so that, often, is just
referred to as base money.

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And in the US and
other countries

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it's often the same thing as M0.

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There's slight differences
from country to country.

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And in this example, as soon
as they printed it and put it

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into circulation, that was $4.

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We had $4 of base money.

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And that's obvious because
as soon as they printed this

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and they bought the
security with it,

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and it was in circulation, that
$4 could be used to buy things.

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It could be used to
facilitate transactions.

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Now that clearly isn't
all of the stuff that

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can be used as money in this
little universe we created.

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This guy, you have the
$4 but these people

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can also write checks
right over here.

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And so we can have a slightly
broader definition of money.

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And over here, we
will call it M1.

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And here, there's a couple of
ways you could think about it.

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You could think about it as
all of the currency that's

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in people's pockets plus all of
the check writing capabilities.

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So if you view it
that way it, would

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be this $2 plus $5 of
check writing capabilities

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right over here.

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So you could have $2
of physical currency

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that's in people's wallets,
not in bank reserves,

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plus the $5 of check
writing capability,

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which would give you $7.

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Another way you
could view it, you

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could view it as M0
plus checkable deposits.

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I'll just write checks
here, plus-- well

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I'll write-- checkable deposits.

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But if you do that,
you are now double

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counting because
some of the M0 is

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reserves in the
checkable deposits.

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Or you could say some of
the checkable deposits

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is held as reserves for M0.

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So then you would have to
subtract out the bank reserves.

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And so then you would
get $4 because we

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don't want to double count
these right over here.

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You would get M0 is $4.

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And I want to do that in white.

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M0 is $4.

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The checkable deposits is $5.

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Let me do that in the pink.

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Plus the $5.

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And then you would want to
subtract out the reserves.

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And the reserves here, there
are $2 of the reserves.

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So minus $2.

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And you would get
yourself back to the $7.

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And the whole point of this is
so you're not double counting

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something, you're not double
counting this right over here,

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as part of checkable
deposits and part of the M0.

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You're not using this twice.

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It's not part of the base money.

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It is both the base money
and checkable deposits.

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And we don't want
to count it twice.

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So the simplest
way to think about

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is, well, what can be used
in this broader definition

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to facilitate transactions?

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These $2 in people's
pockets, and this ability

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to write up to $5 of checks.

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So that's this view
right over here.

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And if we want to get
even broader than that,

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we can get to
something called M2.

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And here we could say,
OK, what's immediately

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usable to facilitate a
transaction right now?

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So that would be our M1.

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So that would be our $7 of M1.

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Plus things that can be
easily converted to M1.

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So for example, these
savings accounts

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can be easily converted
to checking accounts.

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It might only take
a couple of days.

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There might be
some restrictions.

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But it can be converted.

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And when it gets converted
will change the bank's reserve

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requirements a little bit.

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But it will allow, if
this person converts it

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they will have the ability
to write more checks.

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So M2 includes M1
plus things that

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are very easy to convert to M1.

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And so they'll include things
like savings accounts, money

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market accounts, which I
won't go into detail here.

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But they're really kind
of similar in that you

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get slightly higher
interest, but there

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are restrictions on your
ability to access it.

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But it's not too hard to turn
it into checking accounts.

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And small dollar value
time deposit, CD accounts.

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But for the sake of
simplicity, in this example,

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it would be the saving accounts.

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So it would be our
$7 of M1, plus the $2

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of savings accounts
right over here.

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So this is just to
give you a picture.

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When someone talks
about the money

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supply you really
have to say, well,

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what are you talking about?

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The most typical one is that
you're really talking about M1,

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because this is the stuff that's
directly usable to facilitate

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transactions.

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Things like the ability
to write a check,

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or dollar bills in
someone's wallet.

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But they might be talking about
base money, M0, narrow money,

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always of referring
to the same thing,

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especially in the United States.

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Or they might be referring
to something even broader.

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And there are
broader definitions

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even than M2,
although M3, they've

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stopped reporting about it.

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But M3 would have things
that are a little bit further

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from being true money, from
being a checking account.

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But they are already
fairly liquid

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and so they'll include
other types of assets.

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But the Fed has
stopped reporting

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this in the recent past.

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So these are the ones that
are typically referred to.