[Economic Survey] Ch4: Measures of Money Supply, M0-M1-M2-M3-M4; Reserve-Narrow-Broad Money, Money multiplier & Velocity

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  1. Prologue
  2. Factors affecting money supply
  3. WHY should we measure money supply?
  4. M0: Reserve money
  5. M1: Narrow Money
  6. M2
  7. M3 (Broad Money)
  8. M4
  9. Liquidity and ranking
  10. Money multiplier
  11. Velocity of money circulation
  12. Factors affecting Velocity of money circulation
  13. Assertion reasoning type Question

Prologue

Chapter 4: Prices and Monetary Management. FIVE subparts

  1. Inflation indexed bonds
  2. measures of money supply
  3. Monetary policy trends, RBI restructuring
  4. Indexes’ Theory: WPI, CPI, IIP, Services index and others
  5. Indexes’ Current: Survey observations on WPI, CPI & IIP, How to combat inflation

Factors affecting money supply

 

List not exhaustive
SeasonNov to April: crops harvest. Industries buy their raw material = money supply rise
Trade cycle
  • Boom: money supply increases
  • Depression: money supply falls
Fiscal policy
  • Money supply will decrease IF:  higher Taxation and sale of G-sec.
  • But, when Government spends the same money=> money supply will increase => inflation. (e.g. MNREGA)
  • In other words, deficit financing = inflation; bigger fiscal deficit => inflation
Junta’s choiceJunta deposits higher portion of their income in banks => bank can expand loans => money supply rises
Monetary policy
  • RBI’s dear money policy (or Tight money policy)=> supply down
  • RBI’s cheap money policy=> supply rise.

WHY should we measure money supply?

  • So far we learned, what factors affect the money supply.
  • We also know that RBI’s job is to control inflation, by controlling money supply through quantitative and qualitative tools- Repo, MSF, LAF etc. Make sure you’ve read the basics CLICK ME.
  • But for that, first, RBI has to make an objective assessment of “how much” money supply is there in the system? Only then Rajan can make a rational policy to control the money supply. Therefore, they came up with following system:
Table not important, except for RBI interviews
Upto 1967Just “M” = money with public + junta’s demand deposits in banks. (Current account and savings account, CASA)
Upto 1977Aggregate monetary resource (AMR)

  1. Coins and currency
  2. Time Deposits (e.g. Fixed deposit, recurring deposits)
  3. Demand deposits (CA, SA)
From 77 onwardspresent system M0, M1, M2, M3, M4

M0: Reserve money

  • M0 is the base for creating Broad money supply (M3). HOW? Technical explanation given in class12 Macroeconomics page 39 to 44 but cost : benefit not that great.
  • PS: NCERT uses the term High powered money. According to Nadar’s Banking book: M0 = Reserve money = High powered money.
  • Anyways, M0 is the sum of following components:
Numbers not important, just for illustration
ComponentsBillion Rupees in Aug’2014
i) Currency in Circulation13610
ii) Bankers’ Deposits with RBI3567
iii)’Other’ Deposits with RBI97
Total M0: Reserve Money17274

M1: Narrow Money

Measures of Money supply M1 M2 M3 M4 broad money narrow money

M1 includesExcludes
  1. Currency with public
  2. Demand deposit in all banks (e.g. current account, savings account)
  3. Other deposits with RBI
  • India’s deposits with IMF, World bank, Foreign Government etc.
  • Interbank deposits

M2

  • M2= M1 + Post office bank savings*
  • *Similar to regular banks, Post office also offers their time savings account, recurring deposit account, time deposit account. Here we count the Post office savings (=”DEMAND deposit” type) only.

M3 (Broad Money)

  • also called Money aggregate
  • M3 = M1 + Time deposits with commercial banks (Fixed deposits, Recurring deposits).
  • MIND IT: M3= M1+time and NOT M3=M2+time.
Here is real data from RBI:
As of August 2014Billion Rupees
Currency with public13003.9
Bank’s Demand deposits8142.3
Bank’s Time deposits77963.5
other deposits with RBI96.2
Total M3 (Broad Money)99205.8

Numbers not important but interpretation is:

  1. Banks receive more money in TIME deposits than in Demand deposits.
  2. If Banks received more money in  Demand deposits [current account-savings account (CASA)], They’ve to pay less interest (0% and 4%) compared to Time deposits [e.g.Fixed deposits (9%)] = cheaper raw material (money) for loaning to others @13-18% and earning big margin.
  3. Banks have more money >> than with currency with juntaa.

M4

  • M4= M3 + total post office deposits.*
  • *meaning those Post Office “time deposits” and “recurring deposits” also. But excludes national savings certificate etc.

Liquidity and ranking

NAMETYPELIQUIDITY*
M1Narrow moneyhighest
M2Narrow moneyless than M1
M3Broad moneyless than M2
M4Broad moneylowest liquidity
  • *liquidity in the sense the how quickly you can get”Value” into cash.
  • M4 has variety of “TIME DEPOSITS” (Fixed deposits etc) so you can visualize it takes time to “BREAK” those deposits and takeout cash. Hence lowest liquidity among the given.

Money multiplier

  • It is the ratio of Broad money (M3) divided by Reserve Money (M0)
  • Therefore, Broad money (M3) = Reserve Money (M0) x money multiplier
  • In other words, when Reserve money increases, Broad money will also increase. (Direct correlation).
  • For 2013-14, Money multiplier was 5.5.

Just for conceptual clarity, let’s derive for August 2014, using the data from earlier tables

August 2014
M3 Broad money99205
M0 Reserve money17274
Money multiplier (M3 divided by M0)5.74

Velocity of money circulation

  • It is the avg. number of times money passes from one hand to another, during given time period.
  • e.g. you bought pen worth Rs.10 from shopkeeper, he uses same 10 rupee note to buy Cocacola=> then same currency note performed function of TWENTY Rupees. This is called “Velocity of money”
IF Velocity of money ___,Then money supply will__.
IncreasesIncrease
Decreasesdecrease

Factors affecting Velocity of money circulation

  1. Income distribution. Poor people immediately use their money. so, money in the hands of poor=> has higher velocity.
  2. Booming period = higher velocity
  3. If More people use EMI loans for purchase=> higher velocity
  4. Low financial inclusion =>less velocity, because banking penetration is low. People tend to save more in physical assets hence money doesn’t change hands much.
  5. Developed countries => higher velocity, because people save less and spend more because of lifestyle and confidence in Government social-security  e.g. USA

Assertion reasoning type Question

All the answers based on Economic Survey statements. I’ve included some questions from other chapters as well:

Q1.

Assertion (A)Ratio of Broad money M3 to gross domestic product (GDP) has increased in recent years
Reason (R)The penetration of banking services has improved in India.
Correct Answerboth right, R explains A

Q2.

Assertion (A)In 2013-14, there has been significant rise in Reserve money (M0)
Reason (R)RBI’s net credit to centre has increased in 2013-14
Correct Answerboth right, R explains A

Q3

Assertion (A)developing countries will require trillions of dollars for moving towards Sustainable development path
Reason (R)Sustainable development implies higher input cost per unit of outcome in the short run.
Correct Answerboth correct, R explains A

Q4

Assertion (A)in 2013-14, there has hardly any growth in mfg + mining sector.
Reason (R)There has been a deceleration in private investment in these two sectors.
Correct Answerboth correct, R explains A

Q5

Assertion (A)In IIP, coal, fertilizer, electricity, crude oil, natural gas, refinery products, steel, and cement are considered ‘core’ industries.
Reason (R)Their performance has impact on general economic activity as well as other industrial activity.
Correct AnswerBoth correct, R explains A

Q5

Assertion (A)India’s capital goods segment is a weak performer.
Reason (R)In past three years, there has been a steady deceleration in the investment in capital goods sector
Correct AnswerBoth correct, R explains A
unacademy IAS

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48 Comments on “[Economic Survey] Ch4: Measures of Money Supply, M0-M1-M2-M3-M4; Reserve-Narrow-Broad Money, Money multiplier & Velocity”

  1. happy to c!!such a wonderful tool to prepare civils

  2. sir I m preparing for bank exams and I m new to this site. sir you are really superb. sir u have specified macro economies and micro economies. how to differentiate between them.

  3. Sir,

    I cant find the video of this ppt , is it available elsewhere

  4. What is the difference between narrow and broad money supply?

  5. distinguish between broad money supply and narrow money supply

  6. Thanks for ur job sir &I need a calrification what is the diff b/w other deposits with RBI which took place both in M0 and M1..

  7. sir..
    what’s difference b/w M0 and M3

  8. Hi! As a Science student, I couldn`t really understand how “deficit financing” is really Equal to “Inflation”? Please, do clarify..

    Tx!.. :)

  9. Why NSC is not included in M4?

  10. awsome job sir! i`m thanks lot for that great notes

  11. MyId …both are right ..but here written for simplicity.

  12. Great information in a understandable manner

  13. very good information about fiscal information

  14. Murnal sir I’m working as a Lecturer in Economics. I used yor classification of money for 2nd B.A.students. They are CBCS regulation. This is very good information. Thank you sir.

  15. Reserve bank presently provides estimates of the supply of money in terms of M1 concepts of money supply.
    Plz Correct me if I m wrong

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