Question

Explain the narrow definition (M₁) of money supply.

Answer 1

M₁ is the most commonly used measure of money supply because it includes all financial assets that are widely accepted as a medium of exchange. Currency, which is issued by the government and the central bank, is part of M₁ Since it carries legal authority and requires acceptance for all payments in the economy, it is known as legal tender money. This universal acceptability has made currency a key element of the money supply. Similarly, demand deposits held by the public in commercial banks are also treated as money, as they are frequently used for making payments. However, these deposits, often accessed through cheques, are not considered legal tender, as recipients are not legally obligated to accept payment by cheque and can request cash instead. It is important to understand that this definition of money supply falls under what is referred to as the narrow definition of money.

M₁ = Currency held by public + Demand deposits held by public with the commercial banks