Measures of Money Supply –
Many definitions of money supply have been given and many measures have also been developed based on them. Components of money supply have been differentiated on the basis of their functions. For example, demand deposits, credit card and cash or currency which is used by the people primarily as a medium of exchange for buying goods and services and for other transactional purposes is generally called as M1.
Another measure of money supply is M3 which includes both M1 and time deposits held by the public in the banks. Time deposits are used as a store of value.
The main reason for differentiating money in various measures on the basis of its functions is that useful predictions can be made about the likely effects on the economy due to changes in different components of the money supply.
If M1 is increasing, then it can be expected that people are planning to make a large number of transactions.
If M3 is increasing, then it can be expected that people are planning to save more and consume less.
The different measures of money supply are used to do the monetary analysis and to make right monetary policy for economic growth and development.
In India as well as in some other developed countries, four concepts or measures of money supply have been used to classify the money supply.
From April 1977, the Reserve Bank of India has adopted these four concepts or measures of money supply in its analysis of quantum of and variations in money supply.
1. Money Supply M1 or Narrow Money –
The narrow money is composed the currency with the public, demand deposits of the public with the banks and other deposits of the public held with the Reserve Bank of India.
This (narrow money) money supply is the most liquid measure of money supply because the money included in this can easily be used as a medium of exchange.
M1 = C + DD + OD
C = currency with the public
DD = demand deposits of the public with the banks
OD = other deposits of the public with the Reserve Bank of India
Currency with the public includes
a. Notes in circulation
b. Circulation of rupee coins as well as small coins
c. Cash reserves on hand with all banks
Deposits held by a bank in other banks are excluded from this measure.
Other deposits held by the central or state government with RBI such as RBI Employees Pension and Provident Funds are excluded.
Other deposits of RBI includes
a. Deposits of institutions such as UTI, IDBI, IFCI, NABARD etc.
b. Demand deposits of foreign central banks and foreign governments.
c. Demand deposits of IMF and World Bank
2. Money Supply M2 –
M2 is a border concept than M1. M2 includes all components of M1 and saving deposits with the post office saving banks.
M2 = M1 + Savings deposits with the post office saving banks
M2 is different from M1 because savings deposits with the post office saving banks are not as liquid as DD with commercial banks as they are not chequable accounts but they are more liquid than the time deposits.
3. Money Supply M3 or Broad Money –
M3 is a broad concept of money supply. M3 includes all components of M1 and Time Deposits of the public with the banks.
M3 = M1 + Time Deposits of the public with the banks
It is generally believed that the time deposits serves as a store of value and shows the savings of the people. Time deposits are not as liquid as the DD or the savings deposits with the post office savings banks but people can take loans against these time deposits which can be used for transactional purposes.
M3 is also called Aggregate Monetary Resources (AMR).
4. Money Supply M4 –
M4 includes all components of M3 and total deposits with Post Office Savings Organization. This excludes the contributions made by the public to the national saving certificates.
M4 = M3 + Total Deposits with Post Office Savings Organization