2. Although most bank accounts pay some interest, depositors can get a higher interest rate by buying a certificate of deposit, or CD. The difference between a CD and a checking account is that the depositor pays a penalty for withdrawing the money before the CD comes due—a period of months or even years. Small CDs are counted in M2 but not in M1. Explain why they are not part of M1.
Again, the important characteristic of money is its liquidity: how easily it can be used to purchase goods and services. M1, the narrowest definition of the money supply, contains only currency in circulation, traveler’s checks, and checkable bank deposits. CDs aren’t checkable—and they can’t be made checkable without incurring a cost because there’s a penalty for early withdrawal. This makes them less liquid than the assets counted in M1.