Money supply and Monetary aggregates

Economy and Finance

Money supply and Monetary aggregates

29 Aug 2023 Zinkpot 149

What is the money supply? It refers to the stock of money held by the public at a point in time as a means of payment and store of value.
In India, the Reserve Bank of India uses four measures of money supply, namely M1, M2, M3, and M4.
These measures differ from each other in terms of different degrees of liquidity i.e. how easily an asset can be converted into cash and different rate of return or interest rates.
M1 – It includes the money in circulation and demand deposits in the banking system.
M2 – It includes M1, saving deposits, and time deposits with the post office saving banks.
M3 – It includes M1 plus time deposits with commercial banks.
M4 – It includes M3 along with total deposits with post office savings.
M1 and M2 are known as narrow money, while M3 and M4 are known as broad money.
These names are given on the basis of their liquidity. Out of all the components of money supply, the money in circulation component is highly liquid, followed by demand deposits, which can be easily converted into money on demand.
Saving deposits with post office saving banks are next in the line of liquidity. Likewise, the degree of liquidity is less in the case of time deposits, because they can be converted into cash without loss of money, only at the time of maturity.
However, they can also be converted into cash before maturity, if depositors are prepared to suffer some financial loss in terms of lower interest rates.
However, in recent years, the RBI has started using new measures of the money supply as per the suggestions of the VK Reddy committee. These new measures are M0, M1, M2, and M3.
This new measure of money supply has introduced the M0 measure, which is generally known as high-powered money. It includes currency in circulation, plus currency deposits of the commercial banks with RBI and other deposits with RBI.
The central bank has direct control over the high-powered money which is sometimes known as monetary base. It reflects the fact that the overall money supply depends ultimately on the monetary base i.e. the amount of money issued by the central bank.