Money Supply M0 M1 M2 M3

1. Prologue
2. Factors affecting money supply
3. WHY should we measure money supply?
4. M0: Reserve money
5. M1: Narrow Money
6. M2
7. M3 (Broad Money)
8. M4
9. Liquidity and ranking
10. Money multiplier
11. Velocity of money circulation
12. Factors affecting Velocity of money circulation
13. Assertion reasoning type Question

Prologue

Chapter 4: Prices and Monetary Management. FIVE subparts

1. Inflation indexed bonds
2. measures of money supply
3. Monetary policy trends, RBI restructuring
4. Indexes' Theory: WPI, CPI, IIP, Services index and others
5. Indexes' Current: Survey observations on WPI, CPI & IIP, How to combat inflation

Factors affecting money supply

List not exhaustive

Season	Nov to April: crops harvest. Industries buy their raw material = money supply rise
Trade cycle	Boom: money supply increases Depression: money supply falls
Fiscal policy	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's choice	Junta deposits higher portion of their income in banks => bank can expand loans => money supply rises
Monetary policy	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

Upto 1967	Just "M" = money with public + junta's demand deposits in banks. (Current account and savings account, CASA)
Upto 1977	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

Components	Billion Rupees in Aug'2014
i) Currency in Circulation	13610
ii) Bankers' Deposits with RBI	3567
iii)'Other' Deposits with RBI	97
Total M0: Reserve Money	17274

M1: Narrow Money

M1 includes	Excludes
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

• 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	Billion Rupees
Currency with public	13003.9
Bank's Demand deposits	8142.3
Bank's Time deposits	77963.5
other deposits with RBI	96.2
Total M3 (Broad Money)	99205.8

Numbers not important but interpretation is:

1. Banks receive more money in TIME deposits than in Demand deposits.
2. 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.
3. Banks have more money >> than with currency with juntaa.

M4

• 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

NAME	TYPE	LIQUIDITY*
M1	Narrow money	highest
M2	Narrow money	less than M1
M3	Broad money	less than M2
M4	Broad money	lowest liquidity

• *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.

Money multiplier

• 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

	August 2014
M3 Broad money	99205
M0 Reserve money	17274
Money multiplier (M3 divided by M0)	5.74

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__.
Increases	Increase
Decreases	decrease

Factors affecting Velocity of money circulation

1. Income distribution. Poor people immediately use their money. so, money in the hands of poor=> has higher velocity.
2. Booming period = higher velocity
3. If More people use EMI loans for purchase=> higher velocity
4. 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.
5. 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:

Q1.

Assertion (A)	Ratio of Broad money M3 to gross domestic product (GDP) has increased in recent years
Reason (R)	The penetration of banking services has improved in India.
Correct Answer	both right, R explains A

Q2.

Assertion (A)	In 2013-14, there has been significant rise in Reserve money (M0)
Reason (R)	RBI's net credit to centre has increased in 2013-14
Correct Answer	both right, R explains A

Q3

Assertion (A)	developing countries will require trillions of dollars for moving towards Sustainable development path
Reason (R)	Sustainable development implies higher input cost per unit of outcome in the short run.
Correct Answer	both correct, R explains A

Q4

Assertion (A)	in 2013-14, there has hardly any growth in mfg + mining sector.
Reason (R)	There has been a deceleration in private investment in these two sectors.
Correct Answer	both correct, R explains A

Q5

Assertion (A)	In IIP, coal, fertilizer, electricity, crude oil, natural gas, refinery products, steel, and cement are considered 'core' industries.
Reason (R)	Their performance has impact on general economic activity as well as other industrial activity.
Correct Answer	Both correct, R explains A

Q5

Assertion (A)	India's capital goods segment is a weak performer.
Reason (R)	In past three years, there has been a steady deceleration in the investment in capital goods sector
Correct Answer	Both correct, R explains A

Money Supply M0 M1 M2 M3

Source: https://mrunal.org/2014/08/explained-measures-of-money-supply-m0-m1-m3-narrow-money-broad-money-money-multiplier.html

Posted by: vanderpooldient1957.blogspot.com

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