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Money Supply – Features and Measures

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Money is anything that is generally accepted as a medium of exchange, a store of value, a measure of value, and a means for the standard of deferred payment. Money considers everything that can be used for an accomplishment of a business transaction and settlement of the business claims, like currency notes, coins, cheques, etc. There is not just one definition of money, instead, it can be defined legally, functionally, based on liquidity, and based on scope. 

Money Supply 

The total money held by the public of a country at a specific point of time is known as Money Supply. It consists of both cash and deposits that can be easily used as cash. The money supply of a country has a major impact on its economy. If there is a rise in the money supply of an economy, it will be shown as a decline in interest rates and the price of goods and services. However, if there is a decline in the money supply of an economy, it will be shown as a rise in the interest rates and price of goods and services, along with an increase in the bank reserves. 

Features of Money Supply

1. Money supply includes the money held by the public in an economy only. Here, ‘public’ means that sector of the country, which is money-using, i.e., firms and individuals. However, it does not include the money-creating sector of a country, as the amount of money or cash held by them does not mean the actual circulation of money in the country, The money-creating sector of a country includes the Banking system and Government. 

2. Money Supply is a Stock Concept. It means that the money supply is concerned with a particular point of time. 

The money produced by the Reserve Bank of India (RBI) and the Government is known as High-powered Money(H). It includes Currency held by the public and Cash reserves with the banks. High-powered Money is different from Money(M), as Money includes currency and demand deposits of an economy; however, High-powered Money includes cash reserves with banks and the currency of an economy. H is high-powered than Money (M) because cash reserves with the banks serve as an actual base for demand deposit generation of an economy.  

Measures of Money Supply

Till 1967-68, only the narrow measure of the money supply was used by the Reserve Bank of India (RBI). However, since 1977, four measures of money supply have evolved in the economy, i.e., M1, M2, M3, and M4

1. M1

The first and basic measure of the money supply is M1, which is also known as Transaction Money. It is called transaction money because this measure can be directly used to make transactions. The three different components of M1 are Currency and coins with public, Demand deposits of Commercial Banks, and Other deposits with RBI. All of these components can be easily used as a medium of exchange; therefore, it is the most liquid measure of the money supply.

M1 = Currency and coins with public + Demand deposits of commercial banks + Other deposits with Reserve Bank of India

Components of M1

1. Currency and Coins with Public: The first component of transaction money includes coins and paper notes held by the public of a country. It means that any money in the form of coins and paper notes, held by the Government and Banking Sector is not included in transaction money. This component includes coins of denominations of ₹1, ₹2, ₹5, ₹10, ₹20, etc., and paper notes of denominations of ₹10, ₹20, ₹50, ₹100, ₹500, etc. Currency money is also known as Fiat Money, which means the money that must be accepted for all of the debts under law. In other words, fiat money is the money that is under the order or fiat from the government to act as money. Another name for currency and coins with public component of M1 is Legal Tender Money. It is because the money can be used legally for the payment of debts and other obligations. 

2. Demand Deposits of Commercial Banks: The second component of M1 includes the demand deposits of the public with the commercial banks. The account holder of demand deposits can encash them anytime by the issue of cheques. As the demand deposits are readily accepted as a means of payment, they are treated as the currency held. However, only net demand deposits are included in M1. It means that all inter-bank deposits are excluded from this component. Inter-bank deposits are the deposits that are held by the banks on the behalf of other banks. As these kinds of deposits do not include money held by the public, they are not included in the money supply. 

3. Other Deposits with Reserve Bank of India: The last component of M1 includes the deposits held by the Reserve Bank of India on behalf of foreign governments and banks, IMF, World Bank, Public Financial Institutions, etc. However, the deposits of commercial banks and the Indian Government with the Reserve Bank of India are not included in this component. ‘Other deposits with RBI’ do not play a significant role in the formation of the monetary policy of India because it constitutes a small part of M1.

2. M2

The second measure of the money supply is M2, and is a broader concept as compared to M1. It includes M1 and savings deposits with the post office savings bank. One cannot withdraw Savings Deposits with Post Office Saving Bank through cheque; therefore, it cannot be included in demand deposits with the bank, resulting in the evolution of M2

M2 = M1 + Savings Deposits with Post Office Saving Bank 

3. M3

The third measure of the money supply is M3 and is a broader concept as compared to M1. It includes M1 and Net Time Deposits with Bank. 

M3 = M1 + Net Time Deposits with Banks

4. M4

The last measure of the money supply is M4, and is a broader concept as compared to M1 and M3. It includes M3 and Total Deposits with Post Office Saving Bank, but does not include NSC (National Saving Certificate). 

M4 = M3 + Total Deposits with Post Office Saving Bank

Important Facts related to the Measures of Money Supply 

1. All four measures of money supply represent a different level or degree of liquidity. M1 is the most liquid measure of supply, and M4 is the least liquid measure of supply. 

2. M3 is also known as Aggregate Monetary Resources of the Society and is widely used as a measure of supply. 

3. M1 and M2 are usually known as Narrow Money Supply Concepts; however, M3 and M4 are known as Broad Money Supply Concepts. 

Example:

Compute the four measures of the money supply from the following information:

Demand Deposits with Banks ₹70,000
Currency with Public ₹96,000
Other Deposits with RBI  ₹3,600
Total Deposits with Post Office ₹12,500
Time Deposits with Bank ₹3,05,000
Post Office saving bank deposits ₹6,287

Solution: 

The four measures of money supply are M1, M2, M3, and M4

M1 = Currency and coins with public + Demand deposits of commercial banks + Other deposits with Reserve Bank of India

M1 = 96,000 + 70,000 + 3,600

      = ₹1,69,600

M2 = M1 + Savings Deposits with Post Office Saving Bank 

M2 = 1,69,600 + 6,287

      = ₹1,75,887

M3 = M1 + Net Time Deposits with Banks

M3 = 1,69,600 + 3,05,000

      = ₹4,74,600

M4 = M3 + Total Deposits with Post Office Saving Bank

M4 = 4,74,600 + 12,500

      = ₹4,87,100



Last Updated : 06 Apr, 2023
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