Money Supply

Money
 Money is the medium of exchange in the form of coins and banknotes.
 Money is any item or verifiable record that is generally accepted as payment
for goods and services and repayment of debts, such as taxes, in a particular
country or socio-economic context.
 Money is a means of payment and thus a lubricant that facilitates
exchange. Money also acts as a store of value and a unit of account. In the
real world, however, money provides monetary services along with tangible
remuneration – RBI
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FUNCTIONS of Money
1. Medium of exchange
2. Measure of Value
3. It is the unit of account
4. Acts as store of value
5. Basis of credit
6. Standard of postponed payments.
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Historic Forms of Money
Money replaced barter system in the following order
 Live stock : Cow, Horses, Camels, Bulls
 Commodity: Food grains, cereals and pulses
 Shells : Cowrie shells
 Precious Stones: Diamond, ruby, emerald,….
 Precious Metals : Gold, Silver, Copper, Bronze and Lead
 Fiat Money : Metal coins minted and paper currency Issued by governments.
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Indian Money
 Currency : Rupee and Paisa (Subunit of Rupee)
 Bank notes
 Denomination: 5, 10, 20, 50, 100, 200, 500, 2000
 Printed by Reserve Bank of India (RBI)
 Coins
 Minted by India Government Mint (IGM)
 Denomination: 1, 2, 5, 10
 Unofficial Users : Bangladesh, Bhutan, China, Nepal, Srilanka and Zimbabwe.
 Pegged with Bhutan (1:1) and Nepal (1: 1.6)
 Foreign Trade: Denoted as INR and contributes around 1.76% of daily trades
of the world
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Countries and Money
Country Currency Symbol Code
Exchange
rate in INR
% of daily
Trades globally
USA United States Dollar US$ USD 71.59 88.3
European Union Euro Dollar € EUR 78.86 32.3
Japan Yen ¥ JPY 0.66 16.8
UK Pound Sterling £ GBP 92.25 12.8
Australia Australian Dollar A$ AUD 48.54 6.8
Canada Canadian Dollar C$ CAD 53.77 5.0
Switzerland Swiss Franc CHF CHF 71.72 5.0
China Renminbi / Chinese Yuan 元 CNY 10.17 4.3
India Indian Rupee INR 1 1.7
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 It is the availability of money in a country and its frequency of
movement.
 It is the total value of money available in an economy at a given
point of time.
 It is also called as money stock.
 Each central bank of a country defines its own money supply.
 Money supply data is published periodically by the central bank.
Money Supply
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RBI Defines money as follows
Central Banks Money
 M0 : Reserve Money or Base Money.
Money with public, Commercial Banks and Post Offices (PO)
 M1 : Narrow Money.
 M2 : Narrow Money
 M3 : Broad Money
 M4 : Broad Money
Forms of money in India
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It is also known as Base money, monetary base as it is
the monetary base of economy. Its components are
1. Currency in Circulation
2. Commercial Bank’s Deposits with RBI
3. Other deposits with RBI include deposits of
 Foreign central banks
 Financial Institutions
 Development banks
 Non Banking Financial Corporations (NBFCs)
M0 – Reserve Money
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1. Currency with public
2. Demand deposits with the Banking system (current
account, saving account)
3. Deposits with RBI
M1 – Narrow Money
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M1 + Savings deposits of post office savings banks
M2
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M1 + Time deposits with the banking system
• Personal deposits
• Corporate deposits
• Government deposits
• Organizational deposits
M3 – Broad Money
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M3 + Post office Time deposits or Term Deposits
M4
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M0 (Reserve Money) : Also known as Base money, monetary base as it is the monetary base
of economy.
 Bankers’ Deposits with RBI
 Non Bankers’ deposits with RBI
 Currency in Circulation
M1 (Narrow Money)
 Demand deposits with the Banking system (current account, saving account)
 Non Bankers’ deposits with RBI
 Currency in circulation
M2 = M1 + Savings deposits of post office savings banks
M3 (Broad Money) = M1 + Time deposits with the banking system
M4 = M3 + All deposits with post offices
MONEY SUPPLY
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 Supply of money and price movement (inflation) are
correlated which is stated in ‘Quantity Theory of
Money’.
 RBI uses money supply as a tool to control the
economy.
 To stabilize prices, RBI uses money supply as a tool.
 RBI publishes money supply data on Fortnight basis
and reserve money data on weekend basis.
Importance of Money Supply
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 Bank Deposits
 Required Reserve Ratio
 Public desire to hold currency (M1) and deposits (M3)
 Interest rates
 Inflation rate
 Business cycles
Determinants of Money Supply
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Money supply in any country is important to control as it has
influence on the major economic indicators including
1. Price stability
2. GDP
3. Employment
Control of Money Supply
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Central banks uses the following as the major tools to control
money supply
1. Reserve Ratios
2. Interest rates
3. Monetary Policy
4. Open Market Operations (OMO)
Control of Money Supply
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These are ratios prescribed to stabilize money supply. Higher the ratios
lowers liquidity and lower increases liquidity. They are as follow.
1. Cash Reserve Ratio (CRR) : It is the percentage of bank deposits which
banks are required to keep with RBI in the form of reserves or balances. It
was as high as 15% in nineties and 5% right now.
2. Statutory Liquidity Ratio (SLR) : It is the percentage of financial
institutions’ including banks’ time and demand liabilities to be kept with
themselves in non cash form. It was 38.5% in nineties and came down to
18.50%
1. Reserve Ratio
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They have direct impact on the money supply as rate cut
increases the supply and increase in rates lowers the same. High
rates decreases availability of credit and demand decreases
resulting to decrease in inflation. Important benchmark interest
rates are as follows.
A. Rep Rate
B. Bank Rate
2. Interest Rates
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1. Repo rates (5.15%): It is the rate at which RBI lends to its clients against
government securities.
2. Reverse repo rate (4.90): It is the rate at which RBI borrows money from
the commercial banks. High rates decreases availability of credit and
demand decreases resulting to decrease in inflation. This increase in repo
rate and reverse repo rate is a symbol of tightening of the policy.
Increase in repo rate and reverse repo rate is a symbol of tightening of the
policy.
A. REPO Rate
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 It is RBI’s interest rate on loans to commercial and co-operative
banks, development banks and other financial institutions.
 Currently Bank rate is 5.40%
Bank rate / Discount rate (5.40%)
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1. Credit Ceiling
2. Rules
3. Regulations
4. Restrictions
5. Guidelines
6. Moral Suation
3. Monetary Policy
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It is an activity by a central bank to give liquidity or take liquidity in its currency
to a bank or from a bank or among a group of banks. In India RBI does the
following OMOs
1) Short Term operations
A. Repurchase Agreements (Repo)
B. Reverse Repo
2) Outright Purchases (PEMO)
4. Open Market Operations
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Repo is the major tool of RBI to stabilize money supply in the short Term. Repo
is also known as RP, Sale and Repurchase Agreement where RBI buys and Sells
securities for short term.
• Repo : It gives liquidity to the economy by buying securities to pump more
money. RBI Buys securities from banks and financial institutions with an
agreement to buy back at a predetermined price and period.
• Reverse Repo: RBI Sucks money from the economy by selling securities to
take the liquidity. RBI sells securities to banks and financial institutions with
an agreement to sell it back at a predetermined price and period.
Repos
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Repo is an activity by a RBI to give liquidity or take liquidity in its currency to a
bank or from a bank or among a group of banks.
• Give liquidity : Pumps money into economy by buying securities. Repo is the
popular operation where RBI Buys securities from banks and financial
institutions with an agreement to buy back at a predetermined price and
period.
• Take liquidity: Sucks money from the economy by selling securities. Reverse
Repo is the popular operation where RBI sells securities to banks and
financial institutions with an agreement to sell it back at a predetermined
price and period.
Repos
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Demand for Money
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1. Transaction Motive
2. Precautionary Motive
3. Asset Motive
4. Speculative Motive
5. Portfolio Motive
Demand for money
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Stock of money (M1) for daily or regular purchases or
expenses in the form of
 Cash in hand
 Cash in savings or current account
1. Transaction Motive
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Holding idle cash creates demand for M1 which is the
outcome of unforeseen contingencies anticipation like
• Accidents
• Illness
• Surprise guests
• Unplanned travel
2. Precautionary Motive
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The person demands little money for transaction
motive and more money to show of his or her wealth
with bears returns as follows
• M1 for transaction motive.
• M3 for Asset Motive in terms of fixed deposits baring
interest rate.
3. Asset motive
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 J M Keynes established the relationship between holding money and bonds
through interest rates.
 Low future interest rates lead to high demand for current bonds and low
demand for present cash holding.
 High future interest rates lead to low demand for current bonds and high
demand for present cash holding.
4. Speculative Motive
Future Interest rate
speculation
Demand for current bonds Demand for Current cash
holding
Low High Low
High Low High
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 This is propounded by James Tobin
 This is motive is part of risk management in terms of return
 Person can be classified as
 Risk taker : Takes high risk and prefers high return investments
 Risk Averse: Takes low risk and prefers low return investments
 Moderate Risk Taker: Balances both risk and return.
5. Portfolio motive
Type of Risk
Demand for low risk investments
equivalent or close to money
Demand high risk investments like
equity and real assets
Low High Low
Moderate Moderate Moderate
High Low High
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Fisher’s Transactions approach gives the equilibrium of money as follows
MV = PT
Where
 M = Total quantity of money in circulation
 V = Velocity of circulation of money
 P = Average price per unit of T.
 T = Total volume of transactions of goods and services against money
Equilibrium
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Money Supply

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Money Supply