Money Supply

Basic Concepts

Functions of Money

There are four main functions of money :“ Money is a matter of function of four,

A medium, a measure, a standard, a store”

Definition of Money Supply

By Money Supply we mean “ The total stock of monetary median of exchange available to a society for use in connection with the economic activity of the country “

Money Supply has two elements:1) Currency with the Public2) Demand Deposits with the public.

Definition of Money Supply

Two important things about Money Supply which are worth noting are :

1) Money Supply is a stock Concept.2) Money Supply always refers to the amount of

money held by the public.

Elements of Money Supply

1) Currency with the Public:a) Currency notes in circulation issued by the RBIb) The number of rupee notes & coins in

circulationc) Small coins in circulation2) Demand Deposits with the Public:They are also called as Bank Money or Deposit

Money

Elements of Money Supply

Demand Deposits are broadly divided into :a) Demand Deposits: are those deposits which can be

withdrawn by drawing cheques on them.b) Time Deposits: A time deposit (also known as a term

deposit, particularly in Canada, Australia and New Zealand; a bond in the United Kingdom) is a money deposit at a banking institution that cannot be withdrawn for a certain "term" or period of time. When the term is over it can be withdrawn or it can be held for another term. Generally speaking, the longer the term the better the yield on the money. A certificate of deposit is a time-deposit product.

Measures Of Money SupplyWhat Does Monetary Base Mean?

The total amount of a currency that is either circulated in the hands of the public or in the commercial bank deposits held in the central bank's reserves. This measure of the money supply typically only includes the most liquid currencies. Also known as the "money base".

For example, suppose country Z has 600 million currency units circulating in the public and its central bank has 10 billion currency units in reserve as part of deposits from many commercial banks. In this case, the monetary base for country Z is 10.6 billion currency units.

For many countries, the government can maintain a measure of control over the monetary base by buying and selling government bonds in the open market.

Measures Of Money SupplyWhat Does Narrow Money Mean?

A category of money supply that includes all physical money like coins and currency along with demand deposits and other liquid assets held by the central bank. In the United States narrow money is classified as M1 (M0 + demand accounts), while in the U.K. M0 is referenced as narrow money.

The name comes from the fact that M1/M0 are the narrowest or most restrictive ideas of money that are the basis for the medium of exchange within the economy. This category of money is considered to be the most readily available for transactions and commerce

Broad Money

In economics, broad money is the widest measurement of the money supply. It is generally

"One measure of the money supply that includes M1, plus savings and small time deposits, overnight repos at commercial banks, and non-institutional money market accounts. This is a key economic indicator used to forecast inflation, since it is not as narrow as M1 and still relatively easy to track. All the components of M2 are very liquid, and the non-cash components can be converted into cash very easily."

Measures Of Money Supply

Money supply is divided into multiple categories - M0, M1, M2 and M3 - according to the type and size of account in which the instrument is kept. The money supply is important to economists trying to understand how policies will affect interest rates and growth.

Measures Of Money SupplyTwo sets of monetary aggregates series are in vogue in India- old series

and new series.

Under old series there are 4 money aggregates viz, M1, M2, M3 and M4 are complied.

The new series clearly distinguishes between liquidity aggregates from monetary aggregates. Under this series apart from monetary base (Mo) 3 measurements of money supply NM1, NM2 and NM3 and 3 measurements of liquidity aggregates L1, L2, L3 are complied, The components of these series and their definitions are specified by the RBI.

Measures Of Money Supply

What Does M0 Mean?A measure of the money supply which combines any liquid or cash assets held within a central bank and the amount of physical currency circulating in the economy. In the United Kingdom, the M0 supply is also referred to as narrow money.

M0 (M-zero) is the most liquid measure of the money supply. It only includes cash or assets that could quickly be converted into currency. This measure is known as narrow money or monetary base. because it is the smallest measure of the money supply.

Measures Of Money Supply

M0 = Currency in circulation + Bankers’ deposits with the RBI + ‘Other’ deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBI’s claims on banks + RBI’s net foreign assets + Government’s currency liabilities to the public – RBI’s net non-monetary liabilities.

Measures Of Money Supply

What Does M1 Mean?A category of the money supply that includes all

physical money such as coins and currency; it also includes demand deposits.

This is used as a measurement for economists trying to quantify the amount of money in circulation. The M1 is a very liquid measure of the money supply, as it contains cash and assets that can quickly be converted to currency.

Measures Of Money Supply• M1= C + CD + ODWhere C= Currency with the public, which consist of the following :i) Notes in circulationii) Circulation of rupee coins as well as small coinsiii) Cash reserves on hand with all banksDD= Demand deposits with public in the commercial & cooperative banks, were

inter-bank deposits are excluded from this measure.OD= Other deposits held by the central and State governments and few others

such as RBI Employees Pension and PF are excluded.The following items are included :iv) Deposits of Institutes such as UTI, IDBI, IFCI, NABARD etc.v) Demand Deposits of foreign Central Bank and Foreign Governments.vi) Demand Deposits of IMF and World Bank.

Measures Of Money Supply

What Does M2 Mean?A category within the money supply that includes M1 in addition to Savings Deposits with post-Office Savings Banks

M2 is a broader classification of money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions.

M2 = M1 + Savings Deposits with post-Office Savings Banks

Measures Of Money Supply

What Does M3 Mean?The category of the money supply that includes M1 as well as all large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets.

This is the broadest measure of money; it is used by economists to estimate the entire supply of money within an economy. M3 is also called as Aggregate Monetary Resources ( AMR )

M3 = M1 + Time Deposits with the Banks

Measures Of Money Supply

What Does M4 Mean?The measure M4 of money supply includes all the

items of M3 plus total deposits with the post office savings organization. But this excludes contribution made by the public to the National savings certificate.

M4 = M3 + Total Deposits of Post Office Savings organization

Money Aggregates Old Series

• Of all the monetary aggregates under the old series M1 and M3 is widely used for analytical purposes.

• M1 the narrowest measurement of money in India and is closely related to the theoretical concept of money as a medium of exchange. This measurement covers highly liquid forms of assets that are used for making payments.

• M3 is a broader concept of money supply and also reflects the role of money as a store of value.

Monetary Aggregates: New Series

• Under the Working group on Money supply (WGMS), the RBI has revised monetary data since April 1992, and since 1999, has started publishing the new monetary aggregates, namely M0( monetary base), NM1(narrow money), NM2 ( intermediate monetary aggregate) and NM3 ( broad money) based on the residency concept.

• The new series clearly distinguishes between monetary aggregates and liquidity aggregates.

Monetary Aggregates: New Series

NM1= Currency with public+ Demand deposits with the banking system+ other deposits with RBI + Demand liabilities portion of savings deposits with the banking system

NM2= NM1+ time liabilities portion of savings deposits with the banking system+ certificates of deposits issued by banks + term deposits of residents with a contractual; maturity upto and including one year with the banking system ( excluding CDs)

Monetary Aggregates: New Series

NM3= NM2+ Long-term deposits of residents + Call/Term funding from financial institutions = Nm2 + term deposits of residents with a contractual maturity of over one year with the banking system+ Call/Term borrowings from non-depository financial corporations by the banking system.

NM1 includes only non-interest bearing assets monetary liabilities of the banking sector, NM3, on the other hand, is an all encompassing measure that includes long-term deposits. NM2 is an intermediate monetary aggregate that stands in between narrow money NM1 and Broad money NM3.

Monetary Aggregates: New SeriesNm2 partitions the maturity structure of bank deposits into short-term

and long-term time deposits at one year of contractual maturity and indicates the depositors presences in holding money in various degrees of liquidity.

It is noted that the money supply measurements include the cash that is in circulation and the deposits that are held by the public with the banking sector.

Hence the measurement of money supply excludes cash reserves of the commercial banks and also the cash reserves of the government held in the treasury and with the Central Bank. Even the stock o0f monetary gold held with the RBI as a banking to paper currency and as a basis of international money excluded money supply measurements in India.

Liquidity Indicators

Along with the above monetary aggregates for the proper assessment of the liquidity the RBI also complies and evaluates three different liquidity indicators L1, L2 and L3.

L1= NM3+ All deposits with the post office savings banks ( excluding National Savings Certificate)

L2= L1+ Term deposits with term lending institutions and refinancing institutions(FIs) + Term borrowing by FIs + Certificate of deposits issued by FIs

L3= L2+ Public deposits of non- banking financial companies.

Liquidity Indicators

L3 is the broadest measure of liquidity. It encompasses all the items of L2 and public deposits with non-bank financial companies (NBFCs) with a public deposit base of Rs 20 crore and above.

Whereas the liabilities of the depository corporations comprising the RBI and the other banking system are considered for the compilation of monetary aggregates, liabilities of the other financial corporations are considered along with those of depository corporations for measures of liquidity.

Measures of Money SupplyIndia: The Reserve Bank of India defines the monetary aggregates as:Reserve Money (M0): Currency in circulation + Bankers’ deposits with the RBI +

‘Other’ deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBI’s claims on banks + RBI’s net foreign assets + Government’s currency liabilities to the public – RBI’s net non-monetary liabilities.

• M1: Currency with the public + Deposit money of the public (Demand deposits with the banking system + ‘Other’ deposits with the RBI).

• M2: M1 + Savings deposits with Post office savings banks. • M3: M1+ Time deposits with the banking system. = Net bank credit to the

Government + Bank credit to the commercial sector + Net foreign exchange assets of the banking sector + Government’s currency liabilities to the public – Net non-monetary liabilities of the banking sector (Other than Time Deposits).

• M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates).

The End

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