Get the answer of: What is Money Supply?
The value (purchasing power) of money and the cost of credit (interest rates) are determined by supply and demand in much the same manner that prices are determined for such goods as wheat, books or football tickets. Money performs a number of functions.
The functions of money provide us with a descriptive definition: money is a medium of exchange, a measure of value, a store of value and a standard of deferred payments. This descriptive definition serves as a guide for an operational definition of money and the money supply.
By supply of money we refer to the amount of money in circulation in an economy. The total amount of money in circulation depends on how money supply is defined, i.e., what assets are included in its specification. For purposes of monetary (credit) policy, the money supply of a country can be defined ‘narrowly’ or more ‘broadly’.
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‘Narrow’ definitions include only assets possessing ready liquidity (that is, assets which can be used directly to finance a transaction — for example, notes and coins).
‘Broad’ definitions include other assets which are less liquid but are nonetheless important in financing transactions (spending). For example, money in the form of deposits of finance companies such as HDFC or LIC have to be withdrawn and ‘converted’ into a cash — notes and coins — before they can be spent.
The ‘broad definition’ includes the following:
1. Currency plus banks’ till money and operational balances at the central bank (e.g., the Reserve Bank of India) and India’s private sector time bank deposits and public sector rupee deposits;
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2. Currency plus banks’ till money and operational balances at the central bank (e.g., the Reserve Bank of India) and India’s private sector time bank deposits and public sector rupee deposits and Indian residents’ deposits in other currencies;
3. Currency plus banks’ till money and operational balances at the central bank (e.g., the Reserve Bank of India) and India’s private sector time bank deposits and public sector rupee deposits and Indian residents’ deposits in other currencies and net housing finance and development corporation deposits;
4. Currency plus banks’ till money and operational balances at the central bank (e.g., the Reserve Bank of India) and India’s private sector time bank deposits and public sector rupee deposits and Indian residents’ deposits in other currencies and net housing finance and development corporation deposits. India’s private sector holdings of money market instruments (e.g., Treasury Bills) plus natural savings.
There are three determinants of money supply, viz.:
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(i) The high-powered money or base money which consists of currency and reserves of banks,
(ii) The currency-deposit ratio, and
(iii) The reserve-deposit ratio.