MEASUREMENT OF MONEY SUPPLY

 MEASUREMENT OF MONEY SUPPLY

• There is virtually a profusion of different types of money, especially credit money, and this makes measurement of money supply a difficult task. Different countries follow different practices in measuring money supply. 
• The measures of money supply vary from country to country, from time to time and from purpose to purpose. Reference to such different measures is beyond the scope of this unit. Just as other countries do, a range of monetary and liquidity measures are compiled and published by the RBI. Money supply will change if the magnitude of any of its constituents changes.
• In this unit, we shall be concentrating on the Indian case only and in the following discussion, we shall focus on alternative measures of money supply prepared and published by the Reserve Bank of India.
• Since July 1935, the Reserve Bank of India has been compiling and disseminating monetary statistics. Till 1967-68, the RBI used to publish only a single ‘narrow measure of money supply’ (M1) defined as the sum of currency and demand deposits held by the public. From 1967-68, a 'broader' measure of money supply, called 'aggregate monetary resources' (AMR) was additionally published by the RBI. From April 1977, following the recommendations of the Second Working Group on Money Supply (SWG), the RBI has been publishing data on four alternative measures of money supply denoted by M1, M2, M3 and M4 besides the reserve money. The respective empirical definitions of these measures are given below:

M1 = Currency notes and coins with the people + demand deposits of banks (Current and Saving deposit accounts) + other deposits of the RBI.
                         
M2 = M1 + savings deposits with post office savings banks.

M3 = M1 + net time deposits with the banking system. M4= M3 + total deposits with the Post Office Savings Organization (excluding National Savings Certificates).

• The RBI regards these four measures of money stock as representing different degrees of liquidity. It has specified them in the descending order of liquidity, M1 being the most liquid and M4the least liquid of the four measures.
• We shall briefly discuss the important components of each. Currency consists of paper currency as well as coins. Demand deposits comprise the current-account deposits and the demand deposit portion of savings deposits, all held by the public.
•  These are also called CASA deposits and these are cheapest sources of finance for a commercial bank. It should be noted that it is the net demand deposits of banks, and not their total demand deposits that get included in the measure of money supply. 
• The total deposits include both deposits from the public as well as inter- bank deposits. Money is deemed as something held by the ‘public’. Since inter- bank deposits are not held by the public, they are netted out of the total demand deposits to arrive at net demand deposits.
• 'Other deposits’ of the RBI are its deposits other than those held by the government (the Central and state governments), and include demand deposits of quasi- government institutions, other financial institutions, balances in the accounts of foreign central banks and governments, and accounts of international agencies such as IMF and the World Bank. Empirically, whatever the measure of money supply, these 'other deposits' of the RBI constitute a very small proportion (less than one per cent) of the total money supply

Following the recommendations of the Working Group on Money (1998), the RBI has started publishing a set of four new monetary aggregates on the basis of the balance sheet of the banking sector in conformity with the norms of progressive liquidity. The new monetary aggregates are:

Reserve Money = Currency in circulation + Bankers’ deposits with the RBI + Other deposits with the RBI
                = Net RBI credit to the Government + RBI credit to the Commercial sector + RBI’s Claims on banks + RBI’s net Foreign assets + Government’s Currency liabilities to the public– RBI’s net non  - monetary Liabilities

NM1 = Currency with the public + Demand deposits with the banking system + ‘Other’ deposits with the RBI.

NM2 = NM1 + Short-term time deposits of residents (including and up to contractual maturity of one year).

NM3 = NM2 + Long-term time deposits of residents + Call/Term funding from financial institutions

• In the monetary literature, money is usually defined in alternative ways ranging from narrow to broad money. Empirically the M1 (narrow money) is defined as the sum of currency held by the public, demand deposits of the banks and other deposits of RBI. 
• Reserve money is comprised of the currency held by the public, cash reserves of banks and other deposits of RBI. On comparison, we find that the difference between M1 and reserve money is that the former includes the demand deposits while the latter includes the cash reserves of banks. Reserves are commercial banks’ deposits with the central bank for maintaining cash reserve ratio (CRR) and as working funds for clearing adjustments.
• Reserve money, also known as central bank money, base money or high-powered money, needs a special mention as it plays a critical role in the determination of the total supply of money. Reserve money determines the level of liquidity and price level in the economy and, therefore, its management is of crucial importance to stabilize liquidity, growth, and price level in an economy.

The central bank also measures macroeconomic liquidity by formulating various ‘liquidity’ aggregates in addition to the monetary aggregates. While the instruments issued by the banking system are included in ‘money’, instruments, those which are close substitutes of money but are issued by the non-banking financial institutions are also included in liquidity aggregates.

L1= NM3 + All deposits with the post office savings banks (excluding National Savings Certificates).

L2= L1 +Term deposits with term lending institutions and refinancing institutions (FIs) + Term borrowing by FIs + Certificates of deposit issued by FIs.

L3 = L2+ Public deposits of non-banking financial companies