Supply of Money :
- Supply of money refers to the stock of money held by the public at a point of time as a means of payments and store of value.
- Money supply refers to the money held by the ‘public’ in a country. The term ‘public’ here refers to all the private individuals, business firms and institutions operating in the economy. It doesn’t include the producers of money like the central bank, the government and the commercial banks. It means the currency held by the government in treasure and money lying with the central and commercial banks is not included in money supply to avoid double counting.
- Money supply refers to money in circulation, but the money held by the government in its treasury, central and commercial banks in their reserves is not in circulation.
- Money supply is a stock concept and therefore, it is measured at a point of time such as money in circulation in India on 1st January, 2023.
Components of Money Supply :
Total money supply in a country consists of two important components :
1. Currency component
2. Deposit component.
1. Currency Component:
- Currency includes both paper currency / notes and coins issued by the government and the central bank.
- Coins are used for smaller transactions and are also called token money.
- The face value of coins is much higher then their metallic or intrinsic value.
- The coins are a very small component of the modern monetary system.
- The coins are invariably issued by the government.
- Currency notes or paper currency is the most important component of money supply.
- The central bank in every country enjoys the monopoly of issuing currency notes.
- Paper currency is the most widely accepted modes of payment.
- Paper currency and coins are fiat money because they are issued by the order (fiat) of the government.
- They are legally backed by the government that is why they also called legal tender.
2. Deposit Money :
- It refers to the money held by the public with commercial banks on the basis of which cheques can be drawn.
- Demand deposit or deposit money held by the public are also called bank money.
- This money is withdrawable through cheques, which is convenient and safe device of making payment.
- These deposits facilitate the exact amount of payment through cheques.
- Deposit money is not legal tender, but functions as money because of the trust of the persons who make payments through cheques.
Measures of Money Supply in India:
We know that the money supply is the sum of currency in circulation at any given time in a country. It includes both physical cash and accounts that can be accessed in the same way. A country’s economy is profoundly affected by its monetary policy.
Now the question is “How can we measure the amount of money in the economy ?”
There is no one way to calculate the money supply in our economy. Instead, the Reserve Bank of India has developed four alternative measures of money supply in India.
These four alternative measures of money supply are labeled M1, M2, M3 and M4. The RBI will collect data and calculate and publish figures of all the four measures.
1. M1 (Narrow Money) :
M1 includes the currency in circulation. M1 , is the initial and most fundamental monetary aggregate. It is referred to as transaction money because it is useful in making purchase and payments.
M1 includes all the currency notes being held by the public on any given day (C) and demand deposits with all the banks of India (both saving and current account deposits) (DD) and it includes other deposits of the bank kept with RBI (OD) .
M1 = C + DD + OD
M1 = Public Currency + Commercial Bank Demand Deposits + Other Deposits at the Reserve Bank of India
2. M2 (Narrow Money):
M2 is a broader measures of money supply than M1. M2 is calculated by adding the M1 with demand or saving deposit with Post office banks.
Here a question arises that why we excluded the demand deposit of post offices while calculating M1 and why we need a separate component M2 for that.
The answer is the demand deposits with post office is less liquid in comparison to deposits of banks as we can not withdraw the deposit with the help of cheque from a post office.
M2 = M1 + demand or saving deposit of Post office (SD)
M2 = Currency in circulation + Demand Deposit of commercial bank + Saving Deposit of Post office + Other Deposits
3. M3 (Broad Money ) :
M3 consists of all currency notes held by the public (C), all demand deposit with the bank (DD), all the other deposits with RBI (OD) and the net Time deposit of all the banks in the country (TD).
All the fixed deposits (FD) and the recurring deposit RD has done the people in banks are called time deposit.
M3 is less liquid in comparison with M1 and M2 because when someone tries to withdraw money from before the maturity, then bank penalises some amount from the sum.
In M3 only that money is included which are deposited in commercial banks and not in any post office.
M3 = Currency held by public + Demand Deposit with banks + other Deposits with RBI + Time deposit of banks
M3 = M1 + Time Deposit of banks (TD)
4. M4 (Widest Measure of Money Supply):
In contrast to M1 and M3, M4 is a more general indicator of the size of the monetary system.
M4 includes all the aspects of M3 and includes the Total savings of the post office banks of the country (TDP).
It is the least liquid measure of all of them.
M4 = M3 + Post Office Savings
M4 = M3 + TDP
Key Features of Measures of Money Supply:
- Each of the four measures of money supply indicates a unique degree or level of liquidity. The most liquid measures of supply is M1 and the least liquid is M4.
- The aggregate monetary resources of a country (M3) are a popular indicator of availability.
- Unlike M3 and M4, which are considered as the broad money supply measures, M1 and M2 are considered to be the narrow money supply measures.
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