Money Supply – Meaning and Measures of Money Supply

Money Supply – Meaning and Measures of Money Supply!

(a) Meaning of Money Supply (D2010):

The supply of money means the total stock of money (paper notes, coins and demand deposits of bank) in circulation which is held by the public at any particular point of time.

Briefly money supply is the stock of money in circulation on a specific day. Thus two components of money supply are

(i) currency (Paper notes and coins)

(ii) Demand deposits of commercial banks.

Again it needs to be noted that (like difference between stock and supply of a commodity) total stock of money is different from total supply of money.

Supply of money is only that part of total stock of money which is held by the public at a particular point of time. In other words, money held by its users (and not producers) in spendable form at a point of time is termed as money supply.

The stock of money held by government and the banking system are not included because they are suppliers or producers of money and cash balances held by them are not in actual circulation. In short, money supply includes currency held by public and net demand deposits in banks.

Sources of Money Supply:

(i) Government (which Issues one-rupee notes and all other coins)

(ii) RBI (which issues paper currency)

(iii) commercial banks (which create credit on the basis of demand deposits).

(b) Alternative measures of Money Supply (money stock):

In India Reserve Bank of India uses four alternative measures of money supply called M₁, M₂, M₃ and M₄. Among these measures M₁ is the most commonly used measure of money supply because its components are regarded most liquid assets. Each measure is briefly explained below.

(i) M₁ = C + DD + OD. Here C denotes currency (paper notes and coins) held by public, DD stands for demand deposits in banks and OD stands for other deposits in RBI. Demand deposits are deposits which can be withdrawn at any time by the account holders. Current account deposits are included in demand deposits.

But savings account deposits are not included in DD because certain conditions are imposed on the amount of withdrawals and number of withdrawals. OD stands for other deposits with the RBI which includes demand deposits of public financial institutions, demand deposits of foreign central banks and international financial institutions like IMF, World Bank, etc.

(ii) M₂ = M₁ (detailed above) + saving deposits with Post Office Saving Banks

(ii) M₃= M₁ + Net Time-deposits of Banks

(iii) M₄ = M₃ + Total deposits with Post Office Saving Organisation (excluding NSC)

In fact, a great deal of debate is still going on as to what constitutes money supply. Savings deposits of post offices are not a part of money supply because they do not serve as medium of exchange due to lack of cheque facility. Similarly, fixed deposits in commercial banks are not counted as money. Therefore, M₁ and M₂ may be treated as measures of narrow money whereas M₃ and M₄ as measures of broad money.

In practice, M₁ is widely used as measure of money supply which is also called aggregate monetary resources of the society. All the above four measures represent different degrees of liquidity, with M₄ being the most liquid and M4 is being the least liquid. It may be noted that liquidity means ability to convert an asset into money quickly and without loss of value.