Monetary Aggregates
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- Money Stock/Money Supply: Money stock or money supply refers to the total amount of money available in the economy at a particular point of time. It is also called Money Supply.
- It is important to measure money supply as it plays important role in an economy.
- How is money supply measured in India?
- Reserve bank of India, over the years have used various methods of measuring money supply. The current method followed by RBI is based on the recommendations of ‘Working Group on Money Supply: Analytics and Methodology of Compilation) which was formed in 1997 under the chairmanship of Dr. Y. V. Reddy. This working group considered the changing circumstances of Liberalization, Privatization and Globalization (LPG) and suggested changes to ensure that the Indian standards are close to international standards.
- Sectorization of the Economy (for the purpose of monetary and liquidity aggregates)
- The third working group on Money supply (chaired by Y.V. Reddy) has divided the economy into the domestic sector and the rest of the world.
- The domestic sector is further divided into four exclusive sectors: viz.,
i. Households
ii. Non-Financial Commercial Sector
iii. General Government
iv. Financial Corporations (It comprises of the banking sector, consisting of the RBI and the banking systems in India and the other financial corporation sector). The other financial corporation sector comprises development financial institutions such as term lending institutions, refinancing insurance corporations, mutual funds and NBFCs accepting deposits from the public. - The domestic sector can also be classified as money issuing sector and money holding sector.
i. Money issuing sector comprises of RBI and Banking systems in India.
ii. Money Holding Sector comprises households, other financial corporations, and
non-financial commercial sectors. - Monetary and Liquidity Aggregates:
- The third working group on monetary supply recommended two different financial aggregates namely, monetary aggregates and liquidity aggregates.
- The working groups observes: “The partition between monetary and liquidity aggregates has been dictated by the fact while the first relates only to monetary liabilities of the Central Bank and depository corporations‘, i.e., the banking system, the latter also includes select items of financial liabilities of non-depository corporations such as development financial companies, and non-banking financial companies accepting deposits from the pubic apart from post office savings.
i. Note: The Development finance institutions which don’t accept time deposits from public are called non-depository corporations.
ii. Note: Liquidity aggregates include a greater number of financial assets than those included in the Monetary aggregates.
- Monetary Aggregates: The new monetary aggregates (money supply) are of four types. They are:
i. Reserve money or Base Money (M0)
ii. Narrow Money (M1)
iii. Intermediate Money (M2)
iv. Broad Money (M3)
Note: Till 1997, RBI followed the older method which included M1, M2, M3 and M4
A) M0 (RESERVE MONEY OR BASE MONEY OR HIGH-POWERED MONEY): CURRENCY IN
CIRCULATION [BANK + PUBLIC] + BANKERS DEPOSIT WITH RBI
M0 (Reserve Money or High-Powered Money): Currency in Circulation (currency with Bank and Currency with Public) + Bankers’ deposit to RBI.
Currency in circulation = Currency with Public + Currency in deposits of Banks
M0 is also known as the base money as it would set the base of the economy. It is roughly equal to total liability of the RBI (how many notes have been printed by RBI)
B) MONEY SUPPLY: NARROW MONEY (M1) = C + DD + OD
- Where do people keep money when they don’t invest (i.e., where do people keep liquid money)
- C: Currency with public
- DD: Net Demand deposits in Bank (Saving Account + Current Account)
- Note1: We don’t use time deposits (fixed deposits) here as they are not perfectly liquid.
- Note2: Understanding Net Demand Deposits
• Gross Demand Deposits include inter-banking claims i.e., claims of one bank against the other. Net Demand Deposits don’t include inter-banking claims. Inter-banking claims are not a part of demand deposits of people.
- OD: Other Deposits with RBI. It includes:
- Demand deposits with RBI of public financial institutions like NABARD
- Demand deposits with RBI of foreign central banks and of the foreign
governments - Demand deposits of International financial institutions like IMF and World Bank
- Note: M1 doesn’t include:
- Deposits of the government with the RBI
- Deposits of the country’s banking system with the RBI
- Why are cash deposits of the government and of the commercial banks with the RBI not treated as a part of the money supply?
- Because government and commercial banks are creators/suppliers of money. And money held by the creators/suppliers of money is never treated as a part of money supply.
- Understanding the relation between reserve ratio and money supply:
- Person 1 has 100 rupees. He deposits this in ICICI Bank.
- If CRR Is 100%, then M1 = 100
- But if CRR is 10%, Bank will lend this money, 90 rupees to someone (money with public), which in turn may become deposit in another bank (let’s say HDFC). This cycle would continue.
- Here M1 = Deposit with ICICI + Deposit with HDFC + Deposit with third bank + and so on…
- So, if Reserve ratio reduces -> M1 increases (i.e., higher the reserve ratio, lower the money supply)
- In a functional economy, money supply is always greater than 1.
- Money multiplier = Stock of Total Money / Stock of High-powered Money (M0)
C) M2 (INTERMEDIATE MONEY):
- This is called intermediate money because financial assets included in this category are more than those included in M1 but less than those included in M3.
- M2 = M1 + Time Liabilities portion of the saving deposits with the Banking System + Certificates of Deposits issued with Banks + Term Deposits (excluding Foreign Currency Non-Resident (Bank) (FCNR(B)) Deposits) upto one year maturity with banking system.
- It can be rewritten us:
= Currency with the public + Current Deposits with the Banking System + Saving
Deposits with the Banking System + Certificate of Deposits issued by Banks + Term Deposits (excluding FCNR(B). Deposits) upto and including one year maturity with the banking system + other deposits with the RBI.
D) M3 (BROAD MONEY):
- The financial assets included in this category are more than those included in the category of M2. Thus, it defines money in a wider sense. So, it is called Broad Money.
- M3 = M2 + Term Deposits (excluding FCNR (B) deposits) over one year maturity with the Banking System + call borrowings from ‘Non-Depository’ Financial corporations by the banking system.
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Older Methods |
M1: Narrow Money: Currency with public + Demand Deposits of Banks + Other Demand Deposits with RBI |
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M2: Intermediate Money: M1 + Post office’s demand deposit (only savings) |
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M3: Broad Money: M1 + net time deposits (fixed deposits) with commercial banks · If money supply in the country is measured using M3 measure, it is called ‘aggregate monetary resources‘ of the country |
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M4: Broad Money: M3 + Post Office deposits (both demand and time) [other than in the form of National Saving certificates |
- ‘Narrow Money’ and ‘Broad Money’ concept of money supply:
- If M1 or M2 measure are used for estimating total money supply in the country, it is known as ‘narrow money’ concept of money supply.
- If M3 or M4 measures are used for estimating total money supply in the country, it is known as ‘broad money’ concept of money supply.
- The Concept of Liquidity:
- Liquidity of an asset refers to its convertibility into money/cash. Faster an asset can be converted into cash, more liquid it is.
- Chequeable deposits/ demand deposits are highly liquid assets. We can state that M1 includes only those components of money supply which are most liquid.
- Time deposits or time deposits/ fixed deposits are not chequeable deposits. These can’t be withdrawn by issuing a cheque. These deposits are, therefore, less liquid than the demand deposit.
- Accordingly, M3 and M4 measures of money supply includes such components of money supply which are less liquid.
- Liquidity of an asset refers to its convertibility into money/cash. Faster an asset can be converted into cash, more liquid it is.
- Liquidity: M1 > M2 > M3 > M4
- Money Multiplier (Mb) = M3/M0
- M3 = M0 * Mb
- So, if Mb is equal to 5, in this case M0 will be multiplied by 5 to achieve broad money.
- It means, money supply will increase five times.
- Money multiplier is thus telling how the base money multiplies in the banking system of the economy.
- Banks create new money whenever they create loans. When Money multiplier is higher, it indicates the banking system is able to create higher money supply out of money given by central bank.
- Liquidity Aggregates:
- L1 = M3 + All deposits of post office saving banks excluding National Savings Certificates (NSCs)
- L2 = L1 + Term Deposits with Term Lending Institutions and Refinancing institutions (FIs) + Term borrowing by Refinancing Institutions + Certificate of Deposits issued by FIs.
- L3 = L2 + Public Deposit of Non-Banking Finance Companies (NFBCs)
4. MONEY SUPPLY MEASURES REPORTED IN ESI 2022-23
- Reserve Money (M0): Currency in Circulation (CiC) + Bankers’ deposit with RBI.
Reserve Money has increased 10.3% as of Dec 2022 compared to 13% last year. So far, increase in M0 was mainly driven by Banker’s deposit with RBI, with an increase in CRR. CiC has broadly remained stable. - Broad Money (M3): increased by 8.7% YoY as of Dec 2022. From Component side, Aggregate deposit has been the largest component and contributed most to the expansion of M3 during FY23. Among sources, Bank Credit to the commercial sector drove the expansion of broad money and the net bank credit to government supplemented the expansion.
- Share of Bank Credit to commercial sector in M3 increased to 64.3% as on 30th Dec 2022 from 61.1% in the corresponding period of the previous year, reflecting the upswing in the credit disbursal by commercial banks.
