Chapter 27: Problem 29

If you take 100 dollar out of your piggy bank and deposit it in your checking account, how did M1 change? Did M2 change?

Short Answer

Expert verified

In conclusion, moving $100 from a piggy bank to a checking account only changes the composition of M1 (from currency in circulation to checkable bank deposits) but does not affect the overall value of M1 or M2. Both M1 and M2 remain unchanged.

Step by step solution

Understand the initial state of money supply

Initially, we have $100 in cash held in a piggy bank (currency). Since this money is not in a checking account, savings account, or any other type of account, it's only a part of M1 and M2 as currency in circulation.

Move money from piggy bank to checking account

When we take this $100 from the piggy bank and deposit it into a checking account, we're not creating new money nor destroying it, but only moving it from one form of M1 to another form of M1. The $100 is withdrawn as physical currency (part of M1) but then deposited as checkable bank deposits (which is also part of M1).

Analyze the changes in M1 and M2

Since the money was only moved from one element of M1 (currency in circulation) to another (checkable bank deposits), the overall M1 hasn't changed. The amount of currency in circulation decreased by $100, but the checkable bank deposits increased by $100, resulting in a net change of $0. As for M2, since it includes all elements of M1, in addition to savings deposits, small-denomination time deposits, and non-institutional money market funds, and we've only changed the form of M1 components, there is also no change in M2.

Final conclusion

In conclusion, the action of moving $100 from a piggy bank to a checking account only changes the composition of M1 but does not affect the overall value of M1 or M2. Both M1 and M2 remain unchanged.

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