Money Supply

Money Supply is the entire amount of cash and other liquid assets present in an economy on the measurement date. Any notes and coins in circulation and any bank deposits that may be quickly converted into cash are included in the money supply.

The Nation’s Central Bank keeps track of the available currency. A change in the money supply in an economy may impact things like inflation, currency rates, corporate practices, and the price level of securities.

Definition of Money Supply

Money supply means all the money moving around in an economy simultaneously. It’s like a collection of different types of money people use to buy things, save, and keep track of value. This includes the money you can touch (coins and paper bills) and the digital money in your bank accounts. Economists and policymakers closely monitor the money supply as a critical indicator of the overall economic health and potential inflationary pressures within a nation’s financial system.

What is a Money Multiplier?

The money multiplier is a concept employed in economics to illustrate the amplification effect that changes in the monetary base, primarily brought about by central banks, have on the overall money supply within an economy. It elucidates the intricate relationship between the initial increase in base money and the subsequent expansion of the broader money supply through financial institutions’ lending and deposit activities.

The money multiplier is like a magnifying glass for money changes in an economy. When a central bank takes actions that increase the starting amount of money (the base money), the money multiplier shows us how that initial increase can cause a bigger overall growth in the total money people use. It’s like a chain reaction – the more banks lend and people deposit, the more the total money supply grows.

Base Money

Base money, often referred to as the monetary base or high-powered money, represents the fundamental building block of a nation’s money supply. It encompasses physical currency, such as coins and paper currency, held in the hands of the public and within the vaults of commercial banks. Additionally, it includes the reserves maintained by banks at the central bank, which constitute a portion of their required reserves.

Cash Reserve Ratio

The Cash Reserve Ratio (CRR) is a monetary policy instrument utilized by central banks to regulate the amount of liquid funds that commercial banks are mandated to maintain as a percentage of their total deposits. This requirement establishes a financial cushion that enables banks to meet potential withdrawal demands from depositors while simultaneously restricting the extent to which banks can deploy customer deposits for lending and investment activities.

Relation of Money Multiplier and Cash Reserve Ratio

The Cash Reserve Ratio (CRR) influences the money multiplier by affecting the initial amount of reserves available for banks to lend. A higher CRR reduces the potential lending capacity of banks, leading to a lower money multiplier effect and a smaller expansion of the money supply.

Money Supply Indicators: Types  and Calculation

Money supply indicators are crucial measures used in economics to assess the total amount of money circulating within an economy. These indicators provide insights into the availability of money for various economic activities, influencing inflation, interest rates, and overall economic stability. There are several types of money supply indicators, each representing different forms of money in circulation. In this discussion, we will explore these types and delve into their explanations and calculation methods.

1. M0 (MB) – Reserve Money:

M0, also known as reserve money or MB (monetary base), constitutes the most fundamental form of money supply. It comprises physical currency, coins, and commercial banks’ reserves held with the central bank. M0 is the foundation upon which the broader money supply indicators are built. To calculate M0, sum up the currency in circulation and the reserves held by banks with the central bank.

2. M1 – Narrow Money:

M1 is a broader measure of money supply compared to M0. It includes the components of M0 (physical currency and coins) as well as demand deposits, which are funds held in checking accounts that can be quickly accessed for transactions. Calculating M1 involves adding currency in circulation, and demand deposits.

3. M2 – Broad Money:

M2 extends the concept of money supply even further. It encompasses M1 components along with savings deposits, time deposits, and money market mutual funds. Savings deposits include funds held in savings accounts, while time deposits consist of fixed-term accounts with interest. Money market mutual funds are short-term investment vehicles. To compute M2, sum up M1 components and add savings deposits, time deposits, and money market mutual funds.

4. M3 – Extended Broad Money:

M3 represents the most extensive measure of money supply. It incorporates M2 elements and adds larger time deposits, institutional money market funds, and other large liquid assets. M3 aims to capture all forms of highly liquid assets that can easily be converted into spending money. Calculating M3 involves aggregating M2 components and adding larger time deposits and institutional money market funds.

Calculation:

M0 = Currency in Circulation + Bank Reserves

M1 = M0 + Demand Deposits

M2 = M1 + Savings Deposits + Time Deposits + Other Near-Money Assets

M3 = M2 + Large Time Deposits + Institutional Money Market Funds + Other Large Liquid Assets

RBI’s Approach Regarding Supply of Money

The Reserve Bank of India (RBI) employs a prudent approach to managing money supply within the Indian economy. This involves utilizing various monetary policy tools to influence the quantity of money available in the financial system. The RBI employs both quantitative and qualitative measures to regulate the money supply, aiming to achieve price stability and promote economic growth.

Quantitative Measures:

The RBI exercises control over the money supply by adjusting the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR). The CRR mandates the proportion of banks’ deposits that must be kept as reserves with the RBI, thereby limiting the funds available for lending. The SLR necessitates banks to maintain a portion of their assets in the form of government securities, thereby impacting the liquidity available for lending purposes.

Qualitative Measures:

The RBI also employs qualitative tools such as Open Market Operations (OMOs) and issuing various policy rates (like the Repo Rate and Reverse Repo Rate). Through OMOs, the RBI buys or sells government securities to regulate the money supply. On the other hand, policy rates influence the cost of borrowing and lending for banks, affecting credit creation and money supply.

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