M2 Money Supply

What Is M2?

M2 is a measure of the money supply used by economists and the Federal Reserve. It includes:

• Currency in circulation (notes and coins)
• Demand deposits (checking accounts)
• Savings accounts and money market deposit accounts
• Small time deposits (CDs under $100,000)
• Retail money market mutual funds

M2 is one step broader than M1 (just cash and demand deposits) and represents money that is readily accessible for spending.

M2 and Inflation

Monetarist theory (associated with Milton Friedman) argues that "inflation is always and everywhere a monetary phenomenon" — that a sustained rise in the general price level requires a sustained rise in the money supply. The formula MV = PQ (money supply × velocity = price level × real output) implies that if M2 grows faster than real output, prices must rise.

Post-COVID, M2 grew at its fastest rate since WWII (25%+ YoY in 2021), followed by the worst inflation in 40 years — a powerful empirical test of monetarist theory.

M2 Contraction: A Warning Sign

For the first time since the Great Depression, US M2 contracted YoY in 2022–2023 as the Fed's QT drained liquidity. Historical data suggests M2 contraction of more than 2% precedes recessions — another metric supporting hard-landing concerns during that period.

Money Velocity

The weakness of pure M2 analysis is that velocity (how quickly money circulates) is unstable. During COVID, M2 surged but velocity collapsed (people saved stimulus checks), delaying inflation. When velocity recovered as spending normalised, the inflationary impulse hit with a lag.

What to Watch

• YoY M2 growth rate: >8% signals easy money; negative signals tightening
• M2 relative to nominal GDP: When M2/GDP rises far above trend, excess money needs to go somewhere — into inflation or asset prices