Not all 'money' is created equal. Understanding the hierarchy helps you see how money flows through the system.

The Pyramid:

M0/Monetary Base (Top of Pyramid):

• Bank reserves at the Fed + physical currency
• Created by the Fed (highest quality)
• ~$5-6 trillion typically

M1:

• M0 + checking deposits at banks
• Most liquid — spendable immediately
• ~$18 trillion

M2:

• M1 + savings deposits + money market funds + small time deposits
• What most people think of as 'money supply'
• ~$21 trillion

M3+ (Shadow Money):

• M2 + repos + commercial paper + other shadow instruments
• Not officially tracked anymore, but represents most credit
• ~$30+ trillion

The Key Insight:

The Fed controls M0 (the base). Banks multiply M0 into M1 and M2 through lending. Shadow banks multiply further into M3+ through repo and leverage.

Each layer involves more credit and less 'real' money. Each layer can expand (boom) or contract (bust) independently. A shadow banking bust can evaporate M3 even if M0 is stable.

The Money Multiplier:

Traditionally, banks could lend out most of their reserves, creating deposits that became someone else's reserves, which got lent again. This 'multiplier' turned $1 of Fed money into $5-10 of credit.

Post-2008, this multiplier is more complex (shadow banking, reserve levels, regulatory capital), but the concept still applies: the Fed creates base money, and the financial system amplifies it.