Money Supply

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• Money Supply- Narrow money, broad money
• Factors affecting money supply in the Indian economy
• Behaviour of money supply
• Reserve money
• Money multiplier (Broad and narrow)
• Monetary aggregates and liquidity aggregates.
• Monetary policy transmission channels

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What is money supply

What is narrow money?

Narrow money includes currency with the public,demand deposits
and “other” deposits with the RBI.
What is broad money?
Broad money is Narrow money plus the time deposits.
Narrow money is concerned with the price level of goods and
services whereas the broad money is concerned with prices of
various financial and stock market assets.
The currency with the public is the monetary liability of the
monetary authorities, consisting of the Government and the RBI. The
bank deposits are the monetary liabilities of the banks.

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Currency with the public consists of coins and currency notes
issued by the Central bank which are in circulation

Deposit money consists of deposits of the general public with

banks which they can withdraw through bank cheques and ATM
cards .

RBI has two types of deposits – one is the deposits commercial

banks keep with the RBI and the other is the deposits kept by
certain individuals with the RBI like the ex-Governors of the RBI
who are permitted to use RBI like any other commercial banks . In
deposit money we include demand deposits of the People with
commercial bank and with the RBI.
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What is Reserve Money?

1. Currency in circulation: I.e the total amount of notes and coins

issued and circulated by the RBI less the amount held by banks
as cash on hand.(C)
2. Deposits of some people with RBI (DD)
3. Cash Reserves which are actually composed of two parts (I)
Cash Reserves kept by the banks with themselves (ii) Banker’s
deposits with the RBI.(CR)
4. RM=C+DD+CR

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Comparison between Reserve money and common money
M1=C+DD+OD
RM=C+OD+CR
The difference is between CR and DD.
CR: Cash Reserves of banks held partly in their premises and
partly held by the RBI under CR
DD: demand deposits of the general public.
Relationship between CR and DD is as follows:
The Cash reserves of banks is the actual base of the total
deposit structure of the banking system.

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Growth of Reserve Money

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Demand deposits

Includes all banks deposits repayable on demand.

Includes all demand deposits of the non-bank sectors.
Credit balances in overdrafts,
cash credit accounts
deposits payable at call,
overdue deposits, inoperative
current accounts, matured time deposits and cash
certificates, etc. are to be included under this category

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Time deposits

Time deposits consist of (i) fixed deposits, (ii) cash certificates, (iii)
cumulative and recurring deposits, (iv) time liabilities portion of
saving bank deposits, (v) staff security deposits, (vi) margins held
against letters of credit if not payable on demand, (vii) fixed deposits
held as securities for advances and (viii) India Development Bonds and
Resurgent India Bonds

Other Deposits with the RBI: deposits from the central banks of other
countries, surplus earmarked for transfer to government

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Net RBI credit to the Government

 Loans and advances to the central government

 Investment in treasury bills
 Investment in dated government securities- G-Secs for a
tenure of more than one year.
 rupee coins
 (minus) deposits of the central government
 Regarding State Governments, net RBI credit refers to
variation in loans and advances given to them by the RBI net of
their incremental deposits with the RBI, for the State
Governments having accounts with the RBI.

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The Net Foreign Exchange Assets (NFEA) of the banking sector
consists of the net foreign exchange assets of the RBI and the
net foreign currency assets of the banking system. The net
foreign currency assets exclude
(a) Overseas foreign currency borrowings
(b) foreign currency repatriable foreign currency fixed liabilities
with the banking system such as the FCNR and the RIB
(Resurgent India bonds).

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What is broad money multiplier and a Narrrow money multiplier.
(Money supply determination,)

Broad money multiplier is the ratio of M3 or broad money to reserve

money. Narrow money multiplier is the ratio of M1 to reserve money.
By regulating the reserves ratio, the RBI can vary the money multiplier.
When prices are rising or expected to be rising, the RBI can raise the
reserves ratio and reduce the money multiplier.
If commodity supplies are abundant or expected to become abundant in
relation to the money stock, the RBI may reduce the reserves ratio and
thus augment money stock and prevent prices from falling.
C= currency deposit ratio, r= reserves deposit ratio
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*H
Money supply= 1  (1  c)(1  r )

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NM3 =This introduces the residency concept in M3. NM3 is based on
the residency concept and hence do not directly reckon non-resident
foreign currency repatriable fixed deposits in the form of FCNR(B)
deposits, Resurgent India Bonds (RIBs) and India Millennium
Deposits (IMDs).

L1=NM3+postal deposits
L2= L1+ Term deposits+term borrowings of FIs+ certificates
of deposits issued by the financial institutions)
(IDBI,IFCI,ICICI,EXIM bank,SIDBI, NHB)
L3= L2+public deposits of NBFCs

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Bank Credit to the commercial sector

The banking system's credit to the commercial sector would comprise

accommodation in the form of
i) loans, cash credit and overdrafts in both rupees as well as in foreign
currency,
ii) inland and foreign bills purchased and discounted (which together
constitute what is commonly known as bank credit),
iii) investment in all securities other than government securities and
iv) net lending to primary dealers (PDs).
In addition, investments of banks in non SLR securities like commercial
papers, units of UTI and other mutual funds, shares,debentures,
bonds of the public and private non bank sector has also to be
included in the bank credit to the commercial sector.

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Net Non Monetary liabililites of the banking sector

Net non-monetary liabilities (NNML) of the banking sector presently

include
i) capital and reserves, -contingency reserve, asset development
reserve ,
ii) Balances parked abroad in IMF account no .1, The No. 1 Account is
used for IMF transactions and operations, including subscription
payments, purchases, repurchases, repayment of borrowing, and
sales of the member’s currency.
(iii) illiquid provisions such as employees’ provident funds.
(iv) other net liabilities such as, net branch adjustments and other
sundry items

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Monetary transmission channels
(a) Market rates
(b) Asset prices
(c) Expectations/Confidence
(d) Exchange rate

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Objectives of monetary policy
• Price stability
• provision of adequate credit to production sectors of the
economy to support aggregate demand and ensure sustained
growth

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inflation targeting may not be appropriate for India for the following reasons
First, unlike many other developing countries we have had a record
of moderate inflation, with double digit inflation being the exception, and largely socially
unacceptable. Second, adoption of inflation targeting requires the existence of an
efficient monetary transmission mechanism through the operation of efficient financial
markets and absence of interest rate distortions. In India, although the money market,
government debt and forex markets have indeed developed in recent years, they still have
some way to go, whereas the corporate debt market is still to develop.
Third, inflationary pressures still often emanate from significant supply shocks
related to the effect of the monsoon on agriculture, where monetary policy action may
have little role. Finally, in an economy as large as that of India, with various regional
differences, and continued existence of market imperfections in factor and product
markets between regions, the choice of a universally acceptable measure of inflation is
also difficult’’ (Mohan, 2006b).

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