Measurement of Money Stock

Presently the Reserve Bank of India (RBI) uses four concepts of money supply. These are referred to as money stock measures or the measures of monetary aggregates. The four components of money supply are:

 M1 refers to currency with the public (coins and currency notes) + demand deposits of the public (narrow money). M2 refers to M1 + Post office savings deposits. M3 refers to M1 + Time deposits of the public with the banks. M4 refers to M3 + Total post office deposits.

 The RBI uses only two concepts out of the four given above. It uses the narrow money (M1) and broad money (M3). The basic difference between narrow and broad money is in terms of the; inclusion of time deposits in M3. Narrow money does not include time deposits, whereas broad money includes time deposits. As said above, the RBI for the last two decades has been using four concepts of monetary aggregates, i.e., M1, M2, M3 and M4.

 Due to restructuring of the economic indices, we have three new aggregates, i.e., M1, M2 and M3. Following are the new definitions that are prevalent now: M1 refers to currency + demand deposits + other deposits with RBI. M2 refers to M1 + Time liabilities part of the savings deposits with banks + Certificate of Deposits (CDs) issued by banks +Term deposits with a maturity period of less than a year [Foreign Currency Non-Resident (Banks) (FCNR (B) is not included].

 The revised definition of M3 is as follows: M3 refers to M2 + term deposits with banks with a maturity period of more than one year + call/term borrowing of the banking system. M3 is a significant measure and is referred to as broad money. The new concepts are improvements over the earlier concepts in the following ways: - Deposits of post office both savings and others have been excluded.

 -Saving deposits of the people with the

banks have been divided in to short - term ( less than one year) and long-term deposits (more than one year). - Most importantly borrowing of the banking system (call and short-term) is included.

Measurement of Money supply

There are two approaches to measure the money supply in the economy. They are Money Multiplier approach and the Balance sheet or structural approach.

The Money Multiplier Approach

The Central Government issues money in the form of one-rupee notes, coins and small coins. The RBI currency together with the Government money with the commercial banks is treated as Vault Cash. The RBI money together with the Government money constitutes the monetary base which is known as High Powered Money.

 i.e. High Powered Money (H)= Monetary liabilities of the RBI + Government money = Currency with the public (C) + Reserves (R) + Other Deposits with the RBI = C+R ...eqn. no.(1) neglecting the other deposits with the RBI where, Reserves (R) = Vault Cash + Banks Deposits with the RBI =Statutory reserves + Excess reserve ...eqn. no. (2)

 In its simplest form the money multiplier approach is based on the following equation: Ms = m.H where m is the money multiplier and Ms is the broad money (M3). M3 is the sum of currency held by the public (C), demand deposits with the commercial banks (DD) and the time deposits with the banks (TD). or, M3 = C + DD + TD M = M3/H

= C+DD+TD/C+R =C+DD+TD/C+(DD+TD)r where R = (DD + TD) r and r = Reserve Ratio = R/DD+TD Dividing the numerator and denominator by DD we have: 1+C/DD+TD/DD m= ----------------------C/DD + r(1+TD/DD)

= 1+c+t/c+r(1+t) where, c = C/DD and t = TD/DD or, When you consider M1, multiplier can be computed in the following manner: M1 = C + DD and, R = r.DD or, r = R/DD In this case, the value of money multiplier boils down to: m= C+DD/C+R

 H=60 crs., c= .5, r= .1 Deposit Multiplier : 1/c+r*H= 1/.6*60=100crs. Bank Credit Multiplier: 1-r/c+r= 1.5*60=90crs. Money Multiplier: 1+c/c+r= 2.5*60= 150crs.