What is the primary distinction between M1 and M2?

The primary distinction between M1 and M2 is indeed that M1 is more liquid than M2.

M1 includes the most liquid forms of money: physical currency (coins and paper money), demand deposits (checking accounts), and other liquid assets that can be readily converted to cash. Due to this focus on easily accessible funds, M1 is designed to measure the money supply that is quickly usable for transactions.

M2, on the other hand, includes all of M1 plus additional financial assets that are less liquid, such as savings accounts, money market accounts, and time deposits under certain thresholds. While these components of M2 are still considered part of the money supply, they require more time to convert into cash or checking deposits in comparison to M1's components.

Thus, the correct understanding is that M1 represents the most liquid assets, making it more immediate for transactional purposes than M2, which encompasses a broader range of financial assets.