[Economic Survey] Ch4: Measures of Money Supply, M0-M1-M2-M3-M4; Reserve-Narrow-Broad Money, Money multiplier & Velocity
- Factors affecting money supply
- WHY should we measure money supply?
- M0: Reserve money
- M1: Narrow Money
- M3 (Broad Money)
- Liquidity and ranking
- Money multiplier
- Velocity of money circulation
- Factors affecting Velocity of money circulation
- Assertion reasoning type Question
Chapter 4: Prices and Monetary Management. FIVE subparts
- Inflation indexed bonds
- measures of money supply
- Monetary policy trends, RBI restructuring
- Indexes’ Theory: WPI, CPI, IIP, Services index and others
- Indexes’ Current: Survey observations on WPI, CPI & IIP, How to combat inflation
Factors affecting money supply
List not exhaustive
||Nov to April: crops harvest. Industries buy their raw material = money supply rise
- Boom: money supply increases
- Depression: money supply falls
- 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 deposits higher portion of their income in banks => bank can expand loans => money supply rises
- 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
||Just “M” = money with public + junta’s demand deposits in banks. (Current account and savings account, CASA)
||Aggregate monetary resource (AMR)
- Coins and currency
- Time Deposits (e.g. Fixed deposit, recurring deposits)
- Demand deposits (CA, SA)
|From 77 onwards
||present 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
||Billion Rupees in Aug’2014
|i) Currency in Circulation
|ii) Bankers’ Deposits with RBI
|iii)’Other’ Deposits with RBI
|Total M0: Reserve Money
M1: Narrow Money
- Currency with public
- Demand deposit in all banks (e.g. current account, savings account)
- Other deposits with RBI
- India’s deposits with IMF, World bank, Foreign Government etc.
- Interbank deposits
- 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 2014
|Currency with public
|Bank’s Demand deposits
|Bank’s Time deposits
|other deposits with RBI
|Total M3 (Broad Money)
Numbers not important but interpretation is:
- Banks receive more money in TIME deposits than in Demand deposits.
- 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.
- Banks have more money >> than with currency with juntaa.
- 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
||less than M1
||less than M2
- *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.
- 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
|M3 Broad money
|M0 Reserve money
|Money multiplier (M3 divided by M0)
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__.
Factors affecting Velocity of money circulation
- Income distribution. Poor people immediately use their money. so, money in the hands of poor=> has higher velocity.
- Booming period = higher velocity
- If More people use EMI loans for purchase=> higher velocity
- 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.
- 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:
||Ratio of Broad money M3 to gross domestic product (GDP) has increased in recent years
||The penetration of banking services has improved in India.
||both right, R explains A
||In 2013-14, there has been significant rise in Reserve money (M0)
||RBI’s net credit to centre has increased in 2013-14
||both right, R explains A
||developing countries will require trillions of dollars for moving towards Sustainable development path
||Sustainable development implies higher input cost per unit of outcome in the short run.
||both correct, R explains A
||in 2013-14, there has hardly any growth in mfg + mining sector.
||There has been a deceleration in private investment in these two sectors.
||both correct, R explains A
||In IIP, coal, fertilizer, electricity, crude oil, natural gas, refinery products, steel, and cement are considered ‘core’ industries.
||Their performance has impact on general economic activity as well as other industrial activity.
||Both correct, R explains A
||India’s capital goods segment is a weak performer.
||In past three years, there has been a steady deceleration in the investment in capital goods sector
||Both correct, R explains A
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happy to c!!such a wonderful tool to prepare civils
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.
I cant find the video of this ppt , is it available elsewhere
What is the difference between narrow and broad money supply?
Narrow Money and Broad Money. While M1/M0 are used to describe narrow money, M2/M3/M4 qualify as broad money and M4 represents the largest concept of the money supply. Broad money may include various deposit-based accounts that would take more than 24 hours to reach maturity and be considered accessible.
distinguish between broad money supply and narrow money supply
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..
what’s difference b/w M0 and M3
Hi! As a Science student, I couldn`t really understand how “deficit financing” is really Equal to “Inflation”? Please, do clarify..
Dificit financing is when revenue is less than expenditure right, so govt has less money to do it’s business. So it will borrow from RBI (from rbi reserves or ask it to print new currency). When govt will have that money, it will spend on it’s projects, leadinv to flow of money into the market. More money in market = inflation.
Why NSC is not included in M4?
awsome job sir! i`m thanks lot for that great notes
MyId …both are right ..but here written for simplicity.
Great information in a understandable manner
very good information about fiscal information
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.
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
Need sums regarding m1
The factor of “Low Financial Inclusion” resulting into lesser velocity of money seemed incorrect prima-facie. Upon further investigation, I found the correlation to be incorrect. Instead of being directly correlated, they’re inversely correlated.
Source: “https://www.bis.org/publ/qtrpdf/r_qt1503h.pdf”- Ctrl+F(ind) the word “velocity”.
Sir, what are the ‘ other deposits’ with RBI ?
Why national savings certificate is excluded from M4? it is also a kind of term deposit right?