Money supply, its measurement, and its various forms underpin how economists understand liquidity and monetary conditions in an economy.
Must Know
Measuring the Money Supply.
- Narrow Money. The Reserve Bank of India defines M1 as currency with the public, plus demand deposits, plus other deposits with the RBI.
- M2. M2 adds savings deposits with post office savings banks to M1. It sits between the narrow and broad measures.
- Broad Money. M3 adds time deposits with the banking system to M1. It is the most widely tracked aggregate for policy.
- Widest Measure. M4, the widest money-supply measure, includes M3 plus total deposits with the postal savings system.
- Why Four Measures. RBI ranks M1 through M4 by liquidity, from most spendable to least. Each measure serves a different policy question.
- Fiat Money. Fiat money derives its value from government authority and public trust, not from any underlying commodity.
- Near Money. “Near Money” refers to highly liquid assets, like savings deposits, easily convertible to cash.
- RBI Founding. The Reserve Bank of India was established on 1st April 1935, following the recommendations of the Hilton Young Commission.
Good to Know
Notes, Coins, and Demonetisation.
- ₹1 Note. India’s ₹1 currency note is signed by the Finance Secretary, unlike higher-denomination notes signed by the RBI Governor.
- Demonetisation. The demonetisation of ₹500 and ₹1000 notes was announced in November 2016.
- Coin Issuance. Coins in India are issued under the authority of the Central Government, distinct from currency notes issued by the RBI.
Money Supply Mechanics.
- Cash Withdrawal. Withdrawing cash from a bank moves value from demand deposits into currency with the public. M1 does not change.
- Why It Stays Flat. One component of M1 falls while the other rises by the same amount. The total is unchanged.
- Reserve Money. Reserve Money, also called M0, is currency in circulation plus bankers’ deposits with the RBI plus other deposits with the RBI.
- Reserve Money vs Money Supply. Reserve Money measures the RBI’s own monetary liabilities. Money supply measures what the public and businesses hold and can spend.
- Data Release. The RBI publishes money supply data every Friday in its Weekly Statistical Supplement, tracking M3 on a balance-sheet basis.
Test Yourself
Great to Know
Reading Liquidity and Monetary Policy.
- Tracking Liquidity. Understanding the different money-supply measures, M1 through M4, helps economists track exactly how much liquidity exists in an economy at any given time.
- Fiat Flexibility. The shift to fiat money globally, away from commodity-backed currency, gives central banks much greater flexibility in managing monetary policy.
- Institutional Split. The RBI’s dual role, issuing notes while the Government issues coins, is a distinctive institutional split not obvious to most citizens.
- Monetary Targeting History. India used the M1-M4 aggregates from 1977 to 1998. A Working Group led by Dr Y.V. Reddy then introduced new aggregates, NM0 to NM3.
- Inflation Targeting. Since 2016, RBI’s main policy anchor has shifted from monetary aggregates to flexible inflation targeting, using CPI inflation as the target.
- M3 as Benchmark. Despite newer measures, M3 remains the aggregate most often quoted in policy discussion, financial media, and UPSC questions.
Previous Year Questions
Asked as: “The money multiplier in an economy increases with which one of the following?” (UPSC CSP 2021, GS Paper I, and again UPSC CSP 2019, GS Paper I, with the same four options simply reordered). Both years asked for the correct answer: an increase in the banking habit of the population. View this question.
Asked as: “Which one of the following is not the most likely measure the Government/RBI takes to stop the slide of Indian rupee?” (UPSC CSP 2019, GS Paper I). View this question.
Asked as: “If you withdraw ₹1,00,000 in cash from your Demand Deposit Account at your bank, the immediate effect on aggregate money supply in the economy will be” (UPSC CSP 2020, GS Paper I). Cash withdrawn from a bank does not vanish from the money supply. It only changes form. Demand deposits fall by ₹1,00,000, while currency with the public rises by the same amount, so M1 stays unchanged. View this question.
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