# How is Money Created in a Modern Economy? ### Definitions **M0** The narrowest definition of money. M0 refers to the actual physical items, such as $20 bills and coins. **Monetary Base** The monetary base includes paper currency and coins, as well as commercial banks (electronic) deposits at the Federal Reserve. Current regulations require commercial banks to keep some money "in reserve" in order to satisfy the demands of their customers who may wish to withdraw their money. **M1** Consists of US paper currency and coins held by the general public (but not in bank vaults) ### Khan Academy Overview 1. Imagine the central bank literally prints money. 2. They then go out and buy (liquid) securities, likely bonds. 3. Whoever they bought the bonds from will likely transfer that money to a private bank. 4. We then see that the private bank may lend out that money, which may be stored in another private bank, shown below (and detailed nicely [here](https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/ap-financial-sector/definition-measurement-and-functions-of-money-ap/v/money-supply-m0-m1-and-m2)) 5. We can then define the following measures for the total amount of money in the system: 1. **M0/Monetary Base**: $4 2. **M1**: $2 +$5 = $7 (all of the currency in peoples pockets, plus the check writing capabilities) We could also view this as M0 + Checkable deposits. However, if we do that then we are double counting. So, to do this we would then need to subtract out the bank reserves. Hence, M1 = M0 + checkable deposits - reserve deposits 3. **M2**: M1 + $2 savings = $9 M2 = M1 + things that are easy to convert to M1. What is immediately usable to facilitate a transaction right now?  --- Date: 20210627 Links to: [Economics MOC](Economics%20MOC.md) Tags: #review References: * [Standard Open Market Operations: How the Fed and Commercial Banks "Create Money"](https://mises.org/wire/standard-open-market-operations-how-fed-and-commercial-banks-create-money) * [Money Supply: M0, M1, M2, Khan academy](https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/ap-financial-sector/definition-measurement-and-functions-of-money-ap/v/money-supply-m0-m1-and-m2) * How is money created notability