<<–2/”>a >a href=”https://exam.pscnotes.com/Money-supply-2/”>Money Supply is the entire stock of currency and other liquid instruments in a country’s economy as of a particular time. The money supply can include cash, coins and balances held in checking and Savings accounts.
Money Supply can be estimated as narrow or Broad Money.
There are four measures of money supply in India which are denoted by M1, M2, M3 and M4. This Classification was introduced by the Reserve Bank of India (RBI) in April 1977. Prior to this till March 1968, the RBI published only one measure of the money supply, M or defined as currency and demand deposits with the public. This was in keeping with the traditional and Keynesian views of the narrow measure of the money supply.
M1 (Narrow Money) consists of:
(i) Currency with the public which includes notes and coins of all denominations in circulation excluding cash on hand with banks:
(ii) Demand deposits with commercial and Cooperative banks, excluding inter-bank deposits; and
(iii) ‘Other deposits’ with RBI which include current deposits of foreign central banks, financial institutions and quasi-financial institutions such as IDBI, IFCI, etc., other than of banks, IMF, IBRD, etc. The RBI characterizes as narrow money.
M2. which consists of M1 plus post office savings bank deposits. Since savings bank deposits of commercial and cooperative banks are included in the money supply, it is essential to include post office savings bank deposits. The majority of people in rural and urban India have preference for post office deposits from the safety viewpoint than bank deposits.
M3. (Broad Money) which consists of M1, plus time deposits with commercial and cooperative banks, excluding interbank time deposits. The RBI calls M3 as broad money.
M4.which consists of M3 plus total post office deposits comprising time deposits and demand deposits as well. This is the broadest measure of money supply.
High powered money – The total liability of the monetary authority of the country, RBI, is called the monetary base or high powered money. It consists of currency ( notes and coins in circulation with the public and vault cash of Commercial Banks) and deposits held by the Government of India and commercial banks with RBI. If a memeber of the public produces a currency note to RBI the latter must pay her value equal to the figure printed on the note. Similarly, the deposits are also refundable by RBI on demand from deposit holders. These items are claims which the general public, government or banks have on RBI and are considered to be the liability of RBI.
RBI acquires assets against these liabilities. The process can be understood easily if we consider a simple stylised example. Suppose RBI purchases gold or dollars worth Rs. 5. It pays for thr gold or Foreign Exchange by issuing currency to the seller. The currency in circulation in the economy thus goes up by Rs. 5, an item that shows up on the liabilityside of RBI’s Balance sheet. The value of the acquired asset, also equal to Rs. 5, is entered under the appropriate head on the Assets side. Similarly, the RBI acquires debt Bonds or securities issued by the government and pays the government by issuing currency. It issues loans to commercial banks in a similar fashion.
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Money supply is the total amount of money circulating in an economy. It is a measure of the liquidity of an economy and can be used to track economic Growth. The money supply is composed of currency, demand deposits, and other liquid assets.
Currency is the physical money that is in circulation, such as coins and paper money. Demand deposits are the money that is held in checking accounts. Other liquid assets include savings accounts, Money Market funds, and short-term Government Securities.
There are three main measures of money supply: M1, M2, and M3. M1 is the narrowest measure of money supply and includes currency and demand deposits. M2 is a broader measure of money supply and includes M1 plus savings deposits, money market funds, and short-term government securities. M3 is the broadest measure of money supply and includes M2 plus large time deposits and institutional money market funds.
The money supply is affected by a number of factors, including the Federal Reserve’s Monetary Policy, the level of economic activity, and the public’s Demand for Money. The Federal Reserve can control the money supply by buying and selling government securities. When the Federal Reserve buys government securities, it injects money into the economy. When the Federal Reserve sells government securities, it takes money out of the economy.
The level of economic activity also affects the money supply. When the economy is growing, businesses and consumers borrow more money. This increases the demand for money and causes the money supply to grow. When the economy is contracting, businesses and consumers borrow less money. This decreases the demand for money and causes the money supply to shrink.
The public’s demand for money also affects the money supply. When people are more confident about the economy, they are more likely to hold money. This increases the demand for money and causes the money supply to grow. When people are less confident about the economy, they are more likely to spend their money. This decreases the demand for money and causes the money supply to shrink.
High-powered money is the total amount of money that is created by the central bank. It is composed of currency in circulation and bank reserves. Currency in circulation is the physical money that is held by the public. Bank reserves are the deposits that banks hold at the central bank.
High-powered money is important because it is the basis for the money supply. When the central bank creates more high-powered money, it increases the money supply. When the central bank destroys high-powered money, it decreases the money supply.
The central bank can use high-powered money to control the money supply and to influence the economy. For example, if the central bank wants to stimulate the economy, it can create more high-powered money. This will increase the money supply and make it easier for businesses and consumers to borrow money. This will lead to increased spending and economic growth.
Conversely, if the central bank wants to slow down the economy, it can destroy high-powered money. This will decrease the money supply and make it more difficult for businesses and consumers to borrow money. This will lead to decreased spending and economic contraction.
High-powered money is a powerful tool that can be used to influence the economy. However, it is important to use it carefully to avoid causing Inflation or Deflation.
Concept of Money Supply
Money supply is a measure of the total amount of money available in an economy. It is typically calculated by adding up the value of all the currency in circulation, plus all the money held in bank accounts.
There are several different measures of money supply, each with its own purpose. The narrowest measure, M1, includes only currency in circulation and demand deposits. The broadest measure, M3, includes M1 plus savings deposits, time deposits, and money market Mutual Funds.
The money supply is important because it affects the level of economic activity. When the money supply increases, people have more money to spend, which can lead to higher prices and inflation. When the money supply decreases, people have less money to spend, which can lead to lower prices and deflation.
The central bank of a country, such as the Federal Reserve in the United States, controls the money supply through a variety of tools, such as open market operations, reserve requirements, and the DISCOUNT rate.
High Powered Money
High-powered money is the sum of currency in circulation and bank reserves. It is also known as base money or monetary base.
High-powered money is important because it is the only form of money that the central bank can directly control. The central bank can increase or decrease high-powered money by buying or selling Government Bonds in the open market.
When the central bank buys government bonds, it injects money into the economy. This increases high-powered money and can lead to an increase in the money supply.
When the central bank sells government bonds, it takes money out of the economy. This decreases high-powered money and can lead to a decrease in the money supply.
High-powered money is a key factor in determining the level of interest rates in an economy. When high-powered money increases, interest rates tend to fall. This is because there is more money available for lending, which drives down the cost of borrowing.
When high-powered money decreases, interest rates tend to rise. This is because there is less money available for lending, which drives up the cost of borrowing.
Frequently Asked Questions
- What is money supply?
Money supply is a measure of the total amount of money available in an economy. It is typically calculated by adding up the value of all the currency in circulation, plus all the money held in bank accounts.
- What are the different measures of money supply?
There are several different measures of money supply, each with its own purpose. The narrowest measure, M1, includes only currency in circulation and demand deposits. The broadest measure, M3, includes M1 plus savings deposits, time deposits, and money market mutual funds.
- Why is the money supply important?
The money supply is important because it affects the level of economic activity. When the money supply increases, people have more money to spend, which can lead to higher prices and inflation. When the money supply decreases, people have less money to spend, which can lead to lower prices and deflation.
- How does the central bank control the money supply?
The central bank of a country, such as the Federal Reserve in the United States, controls the money supply through a variety of tools, such as open market operations, reserve requirements, and the discount rate.
- What is high-powered money?
High-powered money is the sum of currency in circulation and bank reserves. It is also known as base money or monetary base.
- Why is high-powered money important?
High-powered money is important because it is the only form of money that the central bank can directly control. The central bank can increase or decrease high-powered money by buying or selling government bonds in the open market.
- What is the relationship between high-powered money and interest rates?
High-powered money is a key factor in determining the level of interest rates in an economy. When high-powered money increases, interest rates tend to fall. This is because there is more money available for lending, which drives down the cost of borrowing.
When high-powered money decreases, interest rates tend to rise. This is because there is less money available for lending, which drives up the cost of borrowing.
Which of the following is not a component of money supply?
(A) Currency
(B) Demand deposits
(C) Time deposits
(D) Savings depositsWhich of the following is the most liquid asset?
(A) Currency
(B) Demand deposits
(C) Time deposits
(D) Savings depositsWhich of the following is the most important determinant of money supply?
(A) The discount rate
(B) Reserve requirements
(C) Open market operations
(D) The Money MultiplierIf the reserve requirement is 10%, and the money multiplier is 5, then a $100 increase in the money supply will lead to a total increase in the money supply of:
(A) $100
(B) $1,000
(C) $500
(D) $200If the money supply increases, then which of the following is likely to happen?
(A) Interest rates will decrease
(B) Interest rates will increase
(C) The value of the currency will decrease
(D) The value of the currency will increaseIf the money supply decreases, then which of the following is likely to happen?
(A) Interest rates will decrease
(B) Interest rates will increase
(C) The value of the currency will decrease
(D) The value of the currency will increaseThe Federal Reserve is responsible for:
(A) Setting monetary policy
(B) Supervising and regulating banks
(C) Insuring bank deposits
(D) All of the aboveThe Federal Reserve System is made up of:
(A) 12 regional Federal Reserve Banks
(B) The Board of Governors
(C) The Federal Open Market Committee
(D) All of the aboveThe Federal Open Market Committee is responsible for:
(A) Setting monetary policy
(B) Supervising and regulating banks
(C) Insuring bank deposits
(D) None of the aboveThe discount rate is the interest rate that the Federal Reserve charges banks for loans. If the discount rate is increased, then which of the following is likely to happen?
(A) Banks will borrow less money from the Federal Reserve
(B) Banks will borrow more money from the Federal Reserve
(C) The money supply will decrease
(D) The money supply will increase