Question

All else being equal, how would each of the following affect the demand for M1 and the demand for M2?

A. The maximum number of checks per month that can be written on MMMF and MMDA is raised from three to thirty.
B. The stock market crashes, and further sharp declines in the market are widely feared.
C. Banks introduce oevrdraft protection, under which funds are automatically transfered from savings to checkings as needed to cover checks.
D. A crackdown reduces the illegal drug trade, which is carried out largely in curercy.

Answer 1

Changes such as increased limits on checks for MMMF and MMDA accounts, a stock market crash, introduction of overdraft protection, and a crackdown on illegal activities affect the demand for M1 and M2 money supplies in different ways. Increased liquidity and ease of access to funds generally raise the demand for M1, while reduced currency use lowers it.

Step-by-step explanation:

When analyzing the impact on the demand for M1 and M2 money supplies, several scenarios are considered:A. Increased Check Writing on MMMF and MMDA: If the limit on checks for money market mutual funds (MMMF) and money market deposit accounts (MMDA) increases, it could make these instruments more liquid, thus potentially increasing their substitutability for M1. However, since these are traditionally considered part of M2, this change may blur the lines between M1 and M2, leading to a possible increase in M1 demand if consumers and businesses begin to use these accounts similarly to checking accounts.B. Stock Market Crash:

If the stock market crashes and further declines are feared, there can be an increased demand for liquidity, as investors might prefer holding cash or liquid assets. This could potentially increase the demand for M1, which includes cash and checkable deposits, as people move away from riskier assets.C. Introduction of Overdraft Protection: With banks offering overdraft protection, transferring funds automatically from savings to checking accounts, this feature may increase the functional utility of checking accounts (part of M1), leading to a potential increase in demand for M1 as it enhances convenience and reduces the need for maintaining large balances in checkable accounts to prevent overdrafts.D. Crackdown on Illegal Drug Trade: A reduction in the illegal drug trade, which predominantly uses currency, could lower the currency component of M1, as there would be less need for large cash transactions. This may reduce the overall demand for M1 money supply.Each scenario has different implications for M1 and M2 money supply and can result in increased or decreased demand for these categories of money based on the changes in economic behavior and banking practices.