How do M1 and M2 differ?

M1 and M2 are both measures of the money supply, but they differ in their composition. M1 consists of the most liquid forms of money, which includes cash (physical currency) and checking account deposits. This definition highlights M1 as a measure of money that can be readily used for transactions and spending.

M2, on the other hand, is a broader measure that encompasses everything in M1 while adding additional components like savings accounts, time deposits (such as CDs), and money market accounts. These additional components are less liquid compared to those in M1 but still represent money that can be easily converted into cash or checking deposits.

This distinction explains why the inclusion of cash and checking deposits in M1, along with savings accounts and time deposits in M2, is essential to understanding these monetary categories. Therefore, the statement accurately conveys the relationship between M1 and M2, emphasizing that M2 contains M1 plus other forms of money that are not immediately accessible for spending but can be quickly converted when needed.