Broad Money and Narrow Money

The value of the currency depreciates as inflation rises. This is why the RBI keeps track of money supply by categorizing it as ‘reserve money,’ ‘narrow money,’ and ‘broad money’. Money is the most widely used means of exchange (money). Notes, coins, and bank account deposits are all examples of this money. These are also known as legal tender because no citizen in the country may refuse to accept them for transactions. As a result, the economy’s money supply balance is extremely crucial. When the money supply shrinks, prices in the economy begin to fall, which is known as deflation. However, as the amount of money printed increases and the money supply expands, inflation rises. Two elements are required in mind before falling into the money supply in India or anywhere in the world is:

• Currency held by the Public
• Demand deposits held by the Public

The money supply is a stock variable, much as money demands. Money supply refers to the total amount of money in circulation among the general population at any one moment. M1, M2, M3, and M4 are the four money supply measurements released by the RBI. The following are their definitions:

Narrow Money (M1):

The narrow money concept classifies deposits that are extremely liquid or rapidly withdrawable as part of the money supply. Demand deposits, which may be withdrawn rapidly, or check facilities, for example, are accepted as money alongside currencies. This is called narrow money. At this point, the most liquid components of the money held by the public are:

• Currency Component: This is made up of all the coins and banknotes in circulation.
• Demand Deposit Component: The demand deposit component is the money held by banks by the general public, which may be withdrawn through check withdrawals and ATM withdrawals.

Narrow money (M1) refers to the above two components of public money, namely currency components, and demand deposit components, which together account for the nation’s money supply. Thus,

M1

• M1 = Currency in circulation + Banking System Demand + Other Deposits with the RBI

M2

• Post offices, like conventional banks, provide time-saving accounts, recurring deposits accounts, and time deposits accounts. Only post office savings (= ‘DEMAND deposits’ type) are counted here.
• M2 = M1+ Post office bank savings

Broad Money (M3):  

Broad money includes a broader range of bank deposits and other less liquid assets. Time deposits have a set maturity term and can’t be withdrawn before that time period expires. The wide money is obtained by adding the time depots to the narrow money. M3 stands for this.

In the case of Broad money, a new component called Time Deposit is introduced, which has a defined maturity period and hence cannot be withdrawn before that period expires. When we add time deposits to narrow money, we get wide money (M3), which is calculated as follows:

M3 means:

M3 = Currency with the public = Public Demand Deposits in Banks + Public Time Deposits in Banks

• M3 = M1 + Public Time Deposits with Banks

The Broad money includes all public time deposits with all banks, including cooperative banks.

The following are the parts that makeup M3.

• The Public’s Currency
• Deposits in the Banking System (SAVINGS)
• Bank-issued Certificates of Deposit
• Residents’ Term Deposits with the Banking System having a contractual maturity of up to and including one year
• Deposits with the Reserve Bank of India (RBI) that are categorized as ‘Other’
• Residents’ Term Deposits with the Banking System with a contractual term of more than one year
• The Banking System borrows from ‘Non-depository’ financial firms on a call/term basis

M4 means:

When a fourth component, Post Office Saving Deposits, is added to the M3, it becomes M4.

M4 = Currency in circulation + Public Demand Deposits in Banks + Public Time Deposits in Banks + Post Office Savings.

• M4 = M3 + Savings at the Post Office.

DD refers to net demand deposits held by commercial banks, while CU represents cash (notes and coins) owned by the general public. The word ‘net’ refers to the inclusion of solely public deposits held by banks in the money supply. The money supply does not include interbank deposits held by a commercial bank in other commercial banks.

M1 and M2 are examples of narrow money. M3 and M4 are two types of broad money. The gradations are presented in decreasing order of fluidity. M1 has the highest liquidity and is the easiest to deal with, whilst M4 has the least. The most often used money supply statistic is M3. Another name for it is aggregate monetary resources.

The Multiplier of Money:

The money supply is multiplied by the monetary base: the money multiplier is 1/f.

The money supply increases by 1/f dollars when the Federal Reserve boosts the monetary base by one dollar. If the reserve requirement is f=.10, for example, the money supply grows by ten dollars and the money multiplier is ten.

The fractional banking system’s money multiplier is an important factor.

1. The number of bank deposits rises initially (monetary base)
2. The bank keeps a portion of the deposit in reserves and then lends the remainder out.
3. This bank loan will be re-deposited in banks, enabling more bank lending and a larger money supply.

Money- Multiplier process:

The money-multiplier process illustrates how an increase in the monetary base leads to a doubled increase in the money supply. Assume the Federal Reserve conducts an open-market operation, in which it creates $100 in order to purchase $100 in Treasury securities from a bank. The monetary basis is increased by one hundred dollars.

Because the bank has $100 in extra reserves, it decides to lend them money to earn interest. The money is used to purchase anything by the borrower.

The vendor gets the $100 and puts it in his bank account. Assume that f=10 is the reserve requirement. The bank holds a reserve of.10*$100=$10 and lends the rest $90 in surplus reserves. The money is used to purchase anything by the borrower.

The $90 is received by the vendor and deposited in his bank account. The bank keeps.10*$90 in reserves and lends the other $81 in surplus reserves. The money is used to purchase anything by the borrower.

The seller receives the $81 and puts it in his bank account, and the transaction is completed.

Evaluation of the Money Multiplier:

The sum of the increases at each phase equals the entire rise in the money supply:

                                                         ∆M= 100+90+81+···  

                                                                = 100+100×.90+100×.902 +··· 

A geometric sum that is infinite.

The formula for an infinite geometric sum produces since the first term is 100 and the ratio of consecutive terms is 1-0f=.90

                                                     ∆M= 100 /1-(1-f)=100/f = 1000.

The money multiplier is thus ten: For every one dollar increase in the monetary base, the money supply expands by 10 times.

Conclusion:

The Reserve Bank of India uses the broad money measure to examine the money supply in the economy and modifies its monetary policy over medium and long periods to regulate macroeconomic characteristics such as inflation, consumption, growth, and liquidity.