Money Supply – Understanding the Different Forms..

Demonetisation has brought focus on currency in circulation and different types of money supply. Even though currency in circulation has come down, other forms of money supply do not show similar decrease. How is that so and what are the characteristics and significance of different types of money supply. A look at the same..

The first form of money is Mo also called reserve money and is equal to currency in circulation (CIC) plus banks’ deposits (required as reserves) with RBI. CIC is currency printed by RBI and injected into the economy through purchase of foreign currency, gold or government bonds. Thus, RBI’s liability is not limited to the currency it has actually printed. So, hypothetically, if banks are freed of keeping a reserve with RBI and demand all their money, RBI will have to print that much additional currency to meet its liability. As per RBI data, CIC was Rs 11.9 lakh crore whereas M0 was Rs 16.5 lakh crore at the end of Nov’16.
The second group is M1 also called narrow money and is equal to currency with public (CIC minus cash with banks) plus banks’ demand liability. Thus, it includes the liability of RBI and partial liability of banking sector. The demand liability is a primary source of risk for banks since it would not be able to meet its obligation in case of a scramble for cash withdrawal. To mitigate this risk, banks are required to keep a part of their deposits with RBI. At the end of Nov’16, M1 was Rs 21.2 lakh crore arising out of nearly Rs 10 lakh crore of demand deposit with banks.
M3 or broad money forms the third group of money and includes time liability of the banking system. It is the total liability of RBI plus the banking system. Since it is time liability, it does not cause significant risk to the bank unless there is a significant asset-liability mismatch. While M0 and M1 remain linked to CIC, M3 keeps increasing faster as the economy grows. The ratio of M3 to M0 is called money multiplier and currently stands at more than 5 times, up from close to 3 times in 1990s. With time deposits of close to Rs 100 lakh crore, M3 stands at much high figure of Rs 122 lakh crore. Even though this figure is too large, it is backed by productive assets created in the economy by government/private sector and generate sufficient cashflow to meet the liability. Between Oct and Nov’16, CIC came down by almost Rs 6 lakh crore as a result of demonetisation. While M0 and M1 declined by nearly the same amount, decline in M3 was marginal at Rs 2.3 lakh crore.
But, how does the economy generate so much of M3 from a limited stock of M0? Probably, in another article..

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