Money Supply and Monetary Aggregates
All the money held with public, RBI as well as government is called Total Stock of Money. Money Supply is that part of this Total Stock of Money which is with public. By public we refer to the households, firms, local authorities, companies etc. Thus, public money does not include the money held by the government and the money held as CRR with RBI and SLR with themselves by commercial banks. The reason of excluding the above two categories from money supply is that this money held by the Government and RBI is out of circulation.
Thus, we can conclude that the money in circulation is the money supply. This money may be in the following forms:
- Currency Notes and Coins
- Demand Deposits such as Saving Banks Deposits ,
- Other Deposits such as Time Deposits / Term Deposits / Fixed Deposits
- Post Office Saving Accounts
- Cash in Hand (Except SLR) and Deposits of Banks in other Banks / RBI (except CRR)
In other way, this money has two components viz. Currency Component and Deposit Component. Currency Component consist of all the coins and notes in the circulation, while Deposit component is the money of the general public with the banks, which can be withdrawn by them using cheques, withdrawals and ATMs. Deposit can be either Demand Deposit or Time Deposit. More information about types of deposits is here.
Concepts of Money Supply (Monetary Aggregates)
The Reserve bank of India calculates the four concepts of Money supply in India. They are called Monetary Aggregates or Money Stock Measures. They are as follows:
Narrow Money (M1)
At any point of time, the money held with the public has two most liquid components
- Currency Component: This consists of all the coins and notes in the circulation
- Demand Deposit Component: Demand Deposit component is the money of the general public with the banks, which can be withdrawn by them using cheques, withdrawals and ATMs.
The above two components i.e. currency component and demand deposit component of the public money is called Narrow Money and is denoted by the RBI as M1. Thus,
M1 = Currency with the public + Demand Deposits of public in Banks
When a third component viz. Post office Savings Deposits is also added to M1, it becomes M2.
M2 = M1 + Post Office Savings.
Narrow money is the most liquid part of the money supply because the demand deposits can be withdrawn anytime during the banking hours. Time deposits on the other hand have a fixed maturity period and hence cannot be withdrawn before expiry of this period. When we add the time despots into the narrow money, we get the broad money, which is denoted by M3.
M3 = Narrow money + Time Deposits of public with banks
We note here that the Broad money does not include the interbank deposits such as deposits of banks with RBI or other banks. At the same time, time deposits of public with all banks including the cooperative banks are included in the Broad Money.
Now, we understand that the major distinction between the M1 and M3 is “Treatment of deposits with the banks”. If we go a little deep, the M3 is the treatment of “Time Deposits” of the public, since demand deposits are available against cheques and ATMs.
When you add the Post Office Savings money also into the M3, it becomes M4.
Both M2 and M4 which include the Post office Savings with narrow money and broad money respectively are now a days irrelevant. Post Office savings was once a prominent figure when the banks had not expanded in India as we see them today all around. The RBI releases the data at times regarding the money supply in India and Post Office Savings Deposits have not been updated frequently. There is NOT much change in the money of people deposited with the Post office and RBI did not care to update this money. Further, there was a time when the Reserve Bank used broad money (M3) as the policy target. However, with the weakened relationship between money, output and prices, it replaced M3 as a policy target with a multiple indicators approach. RBI started using the Multiple Indicator Approach since 1998
Currently, Narrow Money (M1) and Broad Money (M3) are relevant indicators of money supply in India. The RBI in all its policy documents, monthly Bulletins and other documents shows these aggregates.
Reserve Money (M0)
The other name of the Reserve Money is “High Powered Money” and also “Monetary Base”. Reserve Money is all the Cash in the economy and denoted by M0. This has the following components:
- Currency with the Public
- Other Deposits with the RBI
- Cash Reserves of the banks held with themselves
- Cash Reserves of the Banks held with RBI
Here we should know that Cash Reserves are also of two types viz. Required Reserves (RR) and Excess Reserves (ER). RR are those reserves which the banks are statutorily required to keep with the RBI. At present the Banks are required to keep 4.25% CRR (Cash Reserve Ratio) of their total time and demand liabilities. All reserves excess of RR are called Excess Reserves. ER are held with the Banks while RR is held with RBI. Banks hold the ER to meet their currency drains i.e. withdrawal of currency by depositors.
Factors affecting Money Supply
Money Supply is affected mainly by two factors viz. Monetary base and Money Multiplier.
- Monetary Base: As the reserve money changes, money supply also changes in the same direction. This means if there is more of reserve money in the system, money supply would increase and vice versa. Please note that most of the changes in the money supply are due to changes in the high powered money.
- Money Multiplier: Money Multiplier is the ratio of the Narrow Money (M1) or the Broad Money (M3) to Reserve Money.
Where m is the money multiplier.
From the above we note that supply of money is product of Money Multiplier (m) and the amount of high powered money or the reserve money.