The Money Supply is the amount of money in an economy.

Monetary policy refer to steps taken by RBI to regulate cost and supply of money in order to achieve certain socio Economic objective like price stabilization full employment, exchange regulation and increased economic growth There is no unique measure to money aggregate Money Supply M: M1 + M2 + M3 + M4 Measures of money supply Even the narrowest of the definitions that are actually useful, M0, is broader than physical notes and coins as it includes banks' deposits with the RBI. The next narrowest measures of money supply are M1 and M2. These add various types of deposits by the private sector with banks and other financial institutions. These are still regarded as narrow measures. They are sometimes referred to as narrow money. The broad money measures (M3, M4 and others) add other types of money such as repos, bank acceptances, commercial paper and bonds. A repurchase agreement (repo) is the sale of securities (usually government debt) tied to an agreement to buy the securities back later. A reverse-repo is the purchase of a security tied to an agreement to sell back later. These agreements can be viewed as loans secured against the security. The effective interest rate is called the repo rate. Narrow money measures aim to measure the money supply that is actually held for use in transactions. Broad measures also include money that may be held as a store of wealth. Control of money supply Governments (through central banks' open market operations) have direct control of M0. The money multiplier relationship means that this control also gives indirect control of broad money. In practice monetary policy targets interest rates, rather than directly targeting money supply. In most countries control of inflation is the policy objective (i.e. interest rates are set to keep inflation at desired levels).

Where the policy target is to stimulate the economy or fund government spending, the increase in the money supply is usually described as printing money. M0 (Reserve Money) M0 is the narrowest definition of money supply in common use. M0 = C + OD + BD The definition used is bank notes and coins in circulation, plus banks' deposits with the RBI and other deposits with RBI. M0 is also known as the monetary base. This term refers to the fact that the money measured by M0 supplies the base on which other forms of money (such as bank deposits) are based. The government is able to control the size of monetary base, and this makes controlling it a key policy issue and an important part of monetary policy. Governments can increase the monetary base by issuing notes and coins and by issuing money in the form of banks' deposits with the central bank. In order to prevent excessive growth of the money supply, and therefore high inflation, governments usually have inflation targets. The issue and purchase of government securities is carried out in order to control interest rates, which in turn influences inflation. This implies that growth in money supply is restricted to a level consistent with the desired rate of inflation. Governments that are short of revenues sometimes simply have the RBI act as a buyer of any government bonds that are not bought by other buyers. This is what is generally called printing money or quantitative easing. The problem with this is that the increase in the money supply causes inflation, usually very high inflation. M1 (Narrow Money) M1 consist of Currency notes and coins with public, Demand deposit, other deposit held with RBI M1 = Cp + OD + DD

The government cannot control M1 as directly and easily as it does the monetary base. However there is a relationship between the monetary base and M1 and broader measures of the money supply, the money multiplier. This means that through control of the monetary base, the reserve requirement and other regulation of banks and money markets, governments can control the money supply at all levels to some extent. Although governments can easily restrict lending (and therefore creation of money), increasing banks propensity to lend is harder as falls in lending and money multiples during the credit crunch have made apparent. M2: M2 = M1 + Saving deposit with post office saving bank M3: M3 is a broad measure of the money supply. M3 consists of the following:

notes and coins in circulation Other Deposits with RBI Demand Deposits Time Deposits

M3 = M1 + Time deposits M4: M4 = M3 + Total deposit with post office organization The growth in money supply must be higher than the growth in the real national Income This stems for two reasons a) As income grows, the demand for money as one of the component of saving tends to increase b) An increase in money supply is also necessitated by gradual reduction of the nonmentioned sector of the economy.

Money multiplier The money multiplier (also called the credit multiplier or the deposit multiplier) is a measure of the extent to which the creation of money in the banking system causes the growth in the money supply to exceed growth in the monetary base. The multiplier is the multiple by which the expansion in the money supply is greater than the increase in the monetary base: if the multiplier is 10, then a Re. 1 increase in the monetary base will cause a Rs. 10 increase in the money supply. Most discussions of the multiplier do not discuss what measure of the money supply is being increased. As it is usually restricted to deposits in banks, this implies that we are talking about M1(most commonly) or M2. Multipliers can also be calculated for broad money measures such as M3and M4. Ms = m*H, where m is the money multiplier and H is High powered money H = Currency in circulation (C) + Reserves (R) + Other deposits with RBI OR High powered money (H) = Monetary liabilities of RBI + Government money In Indian economy we use alternative measure of money as 1) Currency in circulation (C) = (2+3) 2) Currency with public (Cp) 3) Currency with banks (Cb) 4) Other deposits with RBI (OD) 5) Bankers deposits with RBI (BD) 6) Demand deposits (DD) 7) Time deposits (TD) 8) Reserve money (M0) = (1+4+5) 9) Narrow money (M1) = (2+4+6)

10) Broad money (M3) = (9+7) We can identify them as 11) M0= C + OD + BD = Cp + Cb + OD + BD 12) M1= Cp + OD + DD 13) M3= Cp + OD + DD + TD The reserve money contains currency in circulation, other deposits with RBI and bankers deposits with RBI. RBI has control over all these three components. The relationship between various measures of money explains the money supply process in the economy. Initially we will try to understand the relationship between M0 and M1. By definition M0= C + OD + BD = Cp + Cb + OD + BD and M1= Cp + OD + DD Cp and OD are common in both M0 and M1 As we know that the share of OD is negligible we can ignore it for time being. Then 14) M0 = Cp + Cb + BD and 15) M1= Cp + DD In M0 Currency with banks and bankers deposits with RBI can be considered as reserves. The amount of reserves are basically decided according to the policy changes (reserve requirement). So we can rewrite it as 16) M0 = Cp + R The amount of reserves required (according to reserve ratio) is basically decided by the amount of deposits (both demand and time) created by the banks. 17) D= DD+TD 18) Rd = r.D Demand for currency and demand deposits by the public are mostly influenced by same factors. So we assume high correlation between them

19) Cpd = c DDd Similarly demand for time deposits can be considered as a multiple of the demand deposits. 20) TDd = t DDd Now the demand for total deposits will be 21) Dd = (1+t) DDd and The demand for reserves by banks will be 22) Rd = r (1+t).DDd According to (16) M0d = Cpd + Rd 23) M0d = c DDd + r (1+t).DDd 24) M0d = [c + r (1+t)].DDd Solving for 25) DDd =[1/c+r(1+t)] M0d According to (15) M1= Cp + DD and according to (19) Cpd = c DDd Substituting (19) and (25) in (15) we will get 26) M1= c DDd + DDd 27) M1= (c +1)DDd 28) M1= (c +1)/[c+r(1+t)] M0 The expression {(c +1)/[c+r(1+t)]} =m is the money multiplier It explain the relationship between M0 and M1 29) M1= m M0 Similarly from (25) the expression [1/c+r(1+t)] is the demand deposit multiplier. If we simplify both the deposits in to one category as it is very common now a days

We get (1+c)/(c+r) = money multiplier.