What do M1 and M2 refer to in the context of money supply?

M1 and M2 are measures used to quantify the money supply and represent different levels of liquidity in the economy.

M1 is the most liquid form of money, which includes physical currency (coins and paper money) and demand deposits, such as checking accounts that can be quickly accessed for spending. These are considered the "narrowest" form of money because they can be readily used for transactions.

M2, on the other hand, encompasses all elements of M1 and adds additional components that are slightly less liquid. This includes savings accounts, time deposits, and certain types of money market accounts. While these forms of money are not as easily accessible for immediate purchases as cash or checking deposits, they can still be converted into cash or checking deposits relatively quickly.

By highlighting the distinctions in liquidity between M1 and M2, this answer accurately captures the definitions and components of these monetary aggregates, reflecting their roles in economic analysis and policy-making. Understanding these classifications is crucial for studying monetary policy, banking, and overall economic health.