Money Supply and Monetary Aggregates

Money supply is the total stock of monetary assets available in an economy at a given time. It includes currency (notes and coins) in circulation and various types of deposits held by the public in banks and other financial institutions. Monitoring money supply is important because it has a close relationship with inflation, interest rates, and overall economic activity. The RBI measures money supply in India through specific monetary aggregates, denoted as M0, M1, M2, M3 (and sometimes M4), each capturing different components of liquidity from most liquid to more broad.

The monetary aggregates in India are defined as follows:

M0 – Reserve Money (Monetary Base or High-Powered Money)

M0 is the foundation of the money supply. It consists of currency in circulation (all notes and coins held by the public and in tills of banks) plus bankers’ deposits with the RBI (the reserves commercial banks hold with the central bank) plus ‘other’ deposits with RBI. Other deposits include accounts of foreign central banks, governments, and international institutions with the RBI. M0 represents central bank money and is the most liquid form of money. It is called “high-powered” because changes in M0 via RBI’s actions (like printing currency or changing bank reserves) lead to a multiplied effect on broader money supply through the banking system.

M1 – Narrow Money

M1 is the sum of currency with the public (i.e., currency in circulation minus cash held by banks) + demand deposits with the banking system (current accounts, savings accounts on which withdrawals can be made on demand) + ‘other’ deposits with RBI. M1 essentially captures the money readily available for transactions in the economy (cash and readily accessible bank balances). It is a narrow measure focusing on liquid forms of money that can be quickly used for payments. M1 is closely watched as an indicator of immediate liquidity affecting day-to-day transactions.

M2

This is a slightly broader measure than M1. M2 = M1 + savings deposits with the post office savings banks (postal savings accounts). In India, post offices run savings bank schemes which hold public deposits. These savings are not as liquid as bank demand deposits (post office withdrawals can be slower), but they are an accessible store of value for the public. M2 acknowledges that portion of savings. (Note: M2 is not as commonly referenced in India for policy purposes, as postal deposits, while included, are very small share compared to bank deposits.)

M3 – Broad Money

M3 is the most commonly used broad measure of money supply in India. M3 = M1 + time deposits with the banking system. Time deposits refer to fixed deposits, recurring deposits, and other term deposits that banks promise to repay after a fixed period (these are less liquid than demand deposits because they can’t be withdrawn on short notice without penalty).

M3 therefore includes all currency with public and all deposits (demand + time) with banks (plus the small ‘other’ deposits with RBI). It is also called the aggregate monetary resources of the economy. M3 gives a comprehensive picture of money available in the system for use in consumption and investment. Policymakers often track M3 growth as it correlates with economic growth and inflation pressures. The ratio of M3 to M0 is known as the money multiplier, reflecting how much banks multiply the base money into broad money through credit creation.

M4

This is an even broader measure, rarely used in recent times. M4 = M3 + all deposits with post office savings organizations (excluding National Savings Certificates). In other words, M4 adds the total post office deposits (both savings and term deposits in post offices) to the broad money.

M4 captures the fullest liquidity in the system including non-bank retail savings. However, since post office deposits (apart from savings accounts included in M2) are not immediately accessible for payments and represent a relatively small segment, M4 is not a focus for RBI’s policy decisions; it is primarily of academic interest.

Summary

To summarize more succinctly:

• M0 (Reserve Money) – Currency in circulation + Bankers’ deposits with RBI + Other RBI deposits. (Controlled directly by RBI; base for further money creation)
• M1 (Narrow Money) – Currency with public + Demand deposits (current & savings) in banks + Other deposits with RBI. (Highly liquid money available on demand)
• M2 – M1 + Post office savings deposits. (Adds near-liquid savings in PO) – M3 (Broad Money) – M1 + Time deposits in banks. (All bank money, broadest actively used measure)
• M4 – M3 + Total post office deposits. (Broadest including PO deposits)

Significance

These aggregates are crucial for monetary policy. For instance, if M3 is growing far above the economy’s real growth rate, it could signal inflationary pressures building up (too much money chasing goods). The RBI might then act to slow money supply growth via tightening measures.

Conversely, if money supply is too sluggish, it might indicate tight liquidity that could stifle economic growth, prompting RBI to infuse liquidity. Different aggregates serve different analysis purposes: M0 growth can indicate RBI’s policy stance (since RBI largely controls M0 through its balance sheet), while the M3/M0 ratio (money multiplier) indicates how active banks are in creating credit.

Money Multiplier Concept

The money multiplier = M3 / M0. It shows the extent to which the banking system expands the base money. A higher multiplier means banks are lending more aggressively (lower reserve ratios, higher turnover of deposits into loans). RBI’s reserve requirements (like CRR, SLR) and public’s preference for cash vs deposits influence this multiplier. For example, if CRR is raised, banks lend less per unit of M0, thus money multiplier tends to decrease. Typically, India’s money multiplier has been in the range of 5 to 6, meaning broad money (M3) is about 5-6 times the reserve money.