The Supply and Demand of Money

What is Money?
common sense
- Money is the set of assets in an economy that
people regularly use to buy goods and services
from other people.
- Money is anything that is generally
acceptable by the people as a means of
payment in the final settlement of all
transactions including debts.

The Functions of Money

Anything that satisfies the four important function of it,- a Medium of exchange,
- a Unit of measurement of Value
- a Standard of deferred payment
- a Store of Value
A medium of exchange is anything that is readily acceptable as payment
for buying and selling goods and services.
A unit of account is the yardstick people use to post prices and record
debts.
Differed Payment: Payment in future
A store of value is an item that people can use to transfer purchasing power
from the present to the future.
Money is the most liquid assets . Liquidity is the ease with which an asset
can be converted into the economys medium of exchange.

The Kinds of Money

1. Barter System- Goods were exchanged against goods
2. Commodity Money: any money that is both used as a general purpose
medium of exchange and as a tradable commodity in its own right. Ex. Coins
of precious metal.
3. Representative Money: Money that consists of token coins, other physical
tokens such as certificates and even non-physical certificates that can be
reliably exchanged for a fixed qty of commodity such as gold, silver ,oil etc.
4. Credit Money: Any claim against a physical or legal person that can be used
for the purchase of goods and services.
5. Fiat Money: the value of which is determined by legal means (legal tender)
ex. Notes of RBI.
1.Coins- not full bodied money but token money (intrinsic value<face
value)
2.Currency notes: not full-bodied
3.Demand Deposits (with drawable through cheque)
6. Electronic Money:
4

MONEY SUPPLY

Supply of Money
The Supply of Money means the volume of money held by the
public in the country for transaction purpose.
Money is Supplied by
a. Reserve Bank of India,
b. Commercial Banks
c. Central Government of India
Money Supply which is held by the public is generally fixed during
a given year.
Money Stock: Total Volume of money at a point of time,
Ex. Dec 31, 2007, held by the public in the country for transaction
purposes
Money Supply (Ms): Total volume of money during a period of
time, Ex. April 1, 2006- 31 March 2007, held by the public in the
country for transaction purposes
6

Printing of Coins and Currencies Agencies

Involved
MOF
Railways

Police

RBI

RBI's
Presses

Govt
Presses

Mints

Banks
(chests)

Central Gov. Mints Coins

RBI prints Currencies

How much to Print & Mint

Replacement needs ( old worn and tear one)
Incremental needs ( demand for money)
Reserve Stock Requirement Needs
(CRR, SLR, gold reserve, Forex reserve)

Growth rate of GDP

Assess the stock on daily basis
Uses statistical analysis and long-term forecast
Printing/minting allocated between the
presses/mints and delivery schedule decided in
advance
Uses some Statistical models
10

India Cross-movement of Currency

Chandigarh

Noida
New Delhi
Jaipur

Lucknow

Guw ahati
Kanpur
Bhopal

Patna
Salboni

Dew as

Ahamadabad

Calcutta
Calcutta
Nagpur
Mumbai

Nasik

Bhuaneshw ar

Mumbai
Byculla

Hyderabad

Hyderabad

Mysore

Banglore

Chennai

Fresh Notes/Coins from

Press/Mint pass on to the
Press
banks/public only through
RBI offices hence crossMint
Issue Offices movement

Trivandrum

11

Capacity of Presses & Mints

Total annual capacity of Presses: 18 bn

Can print up to 28 bn with two shifts
Total minting capacity: 4,700 mn
RBIs annual needs:
Notes:
Coins:

about 12,000 mn pieces

about 5,000 mn pieces

12

Flow of Notes & Coins

NOTES
Chest branches

Public

COINS
Chest branches & RBI
Offices
Public

RBI Offices

Presses

4 mint-linked RBI Offices

4 Mints
13

Network of Currency Chests

RBI is located only in 18 places for currency operations
Distribution of notes and coins throughout the country is done
through designated bank branches, called chests.
RBI has authorized selected branches of scheduled banks
to establish currency chest.
As of June 30, 2006, there were 4428 currency chests and
4102 small coins depots.
Chest is a receptacle in a commercial bank to store notes
and coins on behalf of the Reserve Bank
Deposit into chest leads to credit of the commercial banks
account and withdrawal is debit

14

Currency Chest More on

Meets currency requirement
of public

Currency Chest Mechanism

Withdraws unfit notes

Net deposit /withdrawal of notes and

coins at the chest is reported on daily
basis to parent Issue Office

Exchange facility from one

denomination to another

Overall deposit or withdrawal leads to

credit or debit of banks account in RBI

Payment requirement of the

Government

Net withdrawal from chests means

expansion of currency and deposits
means contraction

Exchange of mutilated notes

Avoids frequent movement of
cash

Notes in circulation being the liability of

RBI, it adjusts its asset-liability position
centrally for such expansion or
contraction

Chest branch operates with

minimum cash balance

15

RBIs
Empirical Estimation(Definition) of
Money Supply

16

RBI or Empirical Definition of Money:

M0 (Reserve Money), M1(narrow money), M2, M3(broad money)
Mo =Currency in circulation + Banker's deposit with RBI+ Other deposits with RBI

17

Other deposits with RBI= (i) deposits of quasi govt and other financial institutions such as Primary Dealers' balances in the
accounts of foreign centrals banks and govts (iii)accounts of IMF, (iv) provident funds, gratuity and guarantee funds of RBI staff.

Primary dealer is a formal designation of a firm as a market maker of government securities

18

19

20

Reserve Money (M0) =1+2+3-4

10

Sources of Changes in High Powered Money (H)

High Powered Money= reserve Money + Govts Currency Liabilities to the Public

1.

2.
3.

4.

5.
6.

Net Central Bank Credit to Government (i-ii)

i. Claims on Government( loans and advances to Govt +Investment in Govt.
Securities)
ii. Govt Deposits with central bank
Central Bank Credit to Banks
bank rate, reporate etc.
Central Bank Credit to Commercial Sector
Shares/bonds of financial institutions
debentures of cooperative banks
H=M0+GCL
loans to financial institutions
Net Foreign Exchange Assets of Central Bank
a. Investment if Foreign assets
b. Gold
Government's Currencies Liabilities to the Public
a. Rupee Coins and small coins
Net Non-Monetary Liabilities of the Central bank
a. Reserves, b. Paid up reserves, c. other liabilities etc.
High Powered Money(H) =1+2+3+4+5-6

21

Sources of Changes in Broad Money Supply (M3)

1.

Net Bank Credit to Government (a+b)

a. Central bank Net Credit to Govt (i-ii)
i. Claims on Government
ii. Govt Deposits with central bank
b. Other Banks credit to Government
2.
Bank Credit to Commercial Sector (a+b)
a. Central bank Credit to Commercial Sector
b. Other banks Credit to Commercial Sector
3.
Net Foreign Exchange Assets of Banking Sector(a+b)
a. Central banks Net Foreign Exchange Assets
b. Other banks net foreign exchange assets
4.
Net Monetary Liabilities of the Banking Sector(a+b)
a. Net Monetary Liabilities of the Central bank
b. Net Non-Monetary liabilities of Banks
Money Supply(M3) =1+2+3-4

22

11

Commercial Banks
Money(Credit) Supply
Credit Creation

23

24

12

25

26

13

27

28

14

29

30

15

31

High Powered (Reserve) Money,

Money Multiplier and Money Supply

M0 = C+R+OD ..(1) Reserve Money

where R= RR+ER
M1=C+DD+OD.(2)

Narrow Money

R is reserve
RR is Required reserve is the reserve which banks are statutorily
hold with RBI. They have no choice about them.
ER is Excess reserve, all reserves in excess of RR is called as
excess reserve which Banks are free to hold them as cash on hand
with themselves or as balances with the RBI
Since OD is small fraction of total money supply. Its excluded here
32

16

33

M0(H) = C+RR+ER ..(1)

M1(M) =C+DD
.(2)

34

17

35

Demand for Money

36

18

Demand for Money

Whats demand???
Demand means the desire and willingness to have
something with a specific prices at point of time.
What is Demand for money?
Demand for money means the desire and willingness to
have money at specific price a point of time
What determines demand for Money??????
Different schools of thought
Classical Economists
Keynesian Economists
Post Keynesian
Baumol and Tobin
Monetarist Economists
Origin of Demand for Money
Origin is the classical Quantity Theory of Money

37

1.Classical Quantity Theory of Money

1568 by Jean Bodin French Philosopher
1911 by Irving Fisher: Most popular and represents the classical
theory
Fishers (1911) QTM:
MV=PQ .(1) Original
MV= PT .(2) Fisher Version
=>P=MV/T(3)
where
M = quantity of money in circulation
P = weighted average price level or general price level
Q= real output
T= sum of all transactions of goods and services per unit time
V = velocity of circulation of money
= # times money used to purchase output

Including Money Supply created by banks

38

19

1. Demand for Money: Classical Economists

Laidler, The demand for money depends upon the value of

transaction to be undertaken in the economy and equal to a constant
fraction of their transaction

and, Given Money Supply, the equilibrium: MS= Md

MV PT ..........QTM: FisherVers
ion

1
PT
V
Here M denotes Money Supply
ForEqilibr
ium: M s M d , and, M s M s

M d

1
PT
V

1
M d kPT .........(6), where, k
V
or, M d kY,............(7)
where;Y PT

Md/P is the real cash balance

People need money to buy goods
and services.
So money is demanded for
transaction purpose and it depends
upon level of income

.Demand for Money in Cambridge Version

or, M d / P ky
So, M d f (Y )............(8)

39

2. Keynesian Theory of Demand for Money

People hold money in two alternative form
1.
Cash/Currency
2.
Bonds or Securities,
So, 3 Motives of holding demand for money
1. Transactions motive
people hold money to buy stuff
Md rises as income rises,
2. Precautionary motive
people hold money for emergencies
car breakdown, Job loss
Md rises with income
3. Speculative motive
suppose store wealth as money or bonds
high interest rates
bonds more attractive, hold less money
Md negatively related to interest rate
_
P is fixed in entire Keynesian Models

40

20

2. Keynesian Theory of Demand for Money

MT d

1 & 2. Transaction and Precautionary Demand for Money

MTd=f(Y).(10)
and MPd=f(Y)(10) Transaction and Precautionary demand for money
is interest inelastic.
So, MTd=k(Y). (10a) k>0
and MPd=k(Y). (10b) k>0
k is constant proportion of money demand from Real Income for
transaction purpose in transaction demand for money and also
the same in precautionary demand for money.
Md

Y
Total Money

Qty of money demand for transaction

Demand: Md=MTd+Mpd
and precautionary purpose
=>Md=kY(11)

41

2. Keynesian Theory of Demand for Money

3. Speculative Demand for Money
MSpd=f(i)
(12) i>0 and Mspd/ i<0
d
=> Msp =Lo-h*i. (13) Speculative demand for money
h is constant proportion of money demand from interest rates

Liquidity trap means a min rate of interest

beyond which interest rate can not fall and
people wish to hold entire money in idle cash
balance.

42

21

43

2.Keynesian Theory of Demand for Money

Total Demand for Money: Sum of all these demand functions
We know, MT&Pd=f(Y)
i>0 and Mspd/ i<0
MSpd=f(i)
=> Md=MTd+Mpd+Mspd.(14)
=> Md=kY+L0-hi
..(15)
So, Md=f(Y,i)
. (16)
Real money demand depends upon real output and overall interest rates.

44

22

Criticism of Keynesian demand for Money

1. Division between Mtd, Mpd and Mspd is
unreliable.
2. Normal rate of interest and current rate of
interest are not the same. If current rate of
interest is stable people take it as normal rate of
interest. According to Keynes speculative
demand for money is governed by this
difference.
3. For Keynes only two assets, money or bond.
But in reality people can hold money in different
assets.
45

Keynesian theory of Money and Interest Rate

We know MTd+Mspd=Md
Eqm:Ms=Md determines interest rate
=>Mt+Msp=Ms where MS is fixed
=>Md=kY+L0-hi

46

23

Keynesian theory of Money and Interest Rate

Change in Money Market and Interest Rate
1.
Change in Demand for money
1. Change in Transaction Demand

2. Change in Speculative Demand

47

Keynesian theory of Money and Interest Rate

Change in Money Market and Interest Rate
2. Change in Money Supply

48

24

Thank You All

49

3. Friedmans Modern Quantity theory

Milton Friedman (1968)
Money is demand just like any other durable goods.
Money as a sterile form of wealth and money is
demanded for storing wealth.
Md as asset demand.
wealth
return relative to other assets

Determinants of Demand for Money

Ultimate Wealth Holders
Total Wealth: human + non human
Proportion of total wealth to human Wealth (w)
Expected rate of return on money (rm) and fixed
assets (rb), equities (re)
Other variables affecting the utility of money (u)
50

25

3. Friedmans Modern Quantity theory

Milton Friedman (1968)
Md as asset demand <Money is demand just like any other durable
goods
-- wealth
-- return relative to other assets

M d

f (Y p , w , rb , rm , re , rb rm , r rm , e m , u )
P

Yp = permanent income
W= wealth
rb = expected bond return
rm = expected money return
re = expected equity return
e = expected inflation
rb - rm = relative return on bonds
e = expected return on goods
u=other variables affecting utility of money
increase in Yp will increase Md
increase in relative returns of bonds, equity or money

decrease Md

51

3. Friedmans Modern Quantity theory

Theory of asset demand: Md function of wealth (YP) and relative Re of other
assets
M

= f(YP, rb rm, re rm, e rm)

+

Differences from Keynesian Theories

1. Other assets besides money and bonds: equities and real goods
2. Real goods as alternative asset to money implies M has direct effects
on spending
3. rm not constant: rb , rm , rb rm unchanged, so Md unchanged: i.e.,
interest rates have little effect on Md
4.Md is a stable function

Implication of 3:
Md
= f(YP) V =
P

Y
f(YP)

Since relationship of Y and YP predictable, 4 implies V is predictable: Get Qtheory view that change in M leads to predictable changes in nominal income, PY52
2005 Pearson Education Canada Inc.

26

1. Classcial Quantity Theory of Money

Now QTM: MV=PT
=>P=MV/T(3)
PM
Irving Fisher
relates quantity of money to nominal income
2 assumptions
V is constant in short-run
depends on institutions, technology that
change slowly
T is at full employment level (T)
also constant in short-run
_ _
if V, T constant then
A change in M must cause an equal % change in P
53

1. Classcial Quantity Theory of Money: The

Cambridge Version
Developed by Alfred Marshall (1890); Modified by AC Pigou, DH Robertson,
and J M Keynes. Also referred as Neoclassical Theory of Money
According to Cambridge Version, The Price Level is affected by only that part
of Money which People hodl in the form of cash for transaction purpose not
by the total MV as suggested by the classical
So Md= kPQ..(9) Demand for Money in Cambridge Version
P= Price Level
Q= real Income
k = Proportion of money income held for currency and bank deposits
k is difficult to determine
At Eqm: Ms=Md
So, Ms=Md=kPQ
Ms/k= PQ
k=1/v of Fishers equation. SO both k an 1/v are reciprocals.s
54

27

1. Classcial Quantity Theory of Money: The

Cambridge Version
So Md= kPQ..(9) Demand for Money in Cambridge Version
Adv:
Unlike Fishers eq of exchange, the neo classical theory links prices
to the demand fro money not with the supply of money.
links demand for money with money income
bring how changes in demand for money changes price level
Classical Theory of Interest Rate
Classical theory says equilibrium between Md and Ms determines Price
level and not the interest rates
But Keynes first developed the theory of interest rate for the classical
economists and said equilibrium between Md and MS determines the
interest rate . This is called as Loanable fund theory of interest rate or
Neo classical Theory of interest rate.
55

56

28

Thank You All

57

Movement of Treasure
Specially built trucks for short distance
(journey completed during the day)
Railways for long distance, Guarded by
police
Remittance accompanied by officials of
RBI to chests
Further movement from chest to a branch
done by the bank concerned
58

29