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S4M. Money Supply and Demand PDF
S4M. Money Supply and Demand PDF
System
A Medium Of Exchange is anything that is readily acceptable as payment for buying and
selling goods and services.
A Unit Of Account is the yardstick people use to post prices and record debts.
A Store Of Value is an item that people can use to transfer purchasing power
from the present to the future.
Barter System: Goods were exchanged against goods. Corn vs. Rice
Commodity Money which has intrinsic value. Ex. Salt, grains, feathers, cowry
Money: shells, beads and even fish hooks
Representative Consists of token coins, other physical tokens. Gold, silver, oil, bank check
Money: It is backed by 100% precious metal.
Credit Money: Any future monetary claim against an individual Ex. IOUs, bonds, money market
that can be used for the purchase of goods and accounts, and any other form of
services. financial instruments.
Fiat Money: Is a money by declaration. Its the value of 1. Coins: not full bodied money but
determined by legal means (legal tender) ex. Notes token money (intrinsic value<face
value)
of RBI. 2. Currency notes: not full-bodied
money
3. Demand deposits (withdrawable
through cheque)
Electronic Money transfer through electronic media. Debit card, credit card, efts, wire
Money: transfers
Developments and Kinds of Money
Money Supply
The Supply of Money
❖ Who Supplies?
By public we refer to the
a) Reserve Bank of India, : Paper Notes
households, firms, local
b) Central Government of India : Coins
c) Commercial and Cooperative authorities, companies etc.
Banks ( Banking System) : Credit
❖ Money Stock: All the money held with the Reserve Bank of India (RBI), the
Government as well as the Public is called the total stock of money.
❖ Money Supply:
o Means that part of the total stock of money (paper notes, coins and demand
deposits of bank) in circulation which is held by the public.
o at any particular point of time for spending purpose.
o Generally fixed during a given year. Ex 31 Aug. 2019
o The stock of money held by government and the banking system are not
included in Money Supply
o because they are suppliers or producers of money and cash balances held by
them are not in actual circulation.
o Money supply includes currency held by public only for spending ( transaction)
purpose and net demand deposits in banks.
Supply of Money: Dimensions
Too little value of the lower denominations
Supply of Money
How much to Print & Mint
❑ Replacement needs ( old worn and tear one)
As of June 30, 2006 there were 4428 currency chests and 4102 small coins depots.
As of Dec 31, 2017 there were 4034 currency chests and 3707 small coins depots.
Supply of Money
Currency Chest: Role Currency Chest :Mechanism
What assets
should be
considered part of
the money
supply?
RBI or Empirical Definition of Money:
https://www.investopedia.com/terms/m/moneysupply.asp
RBI or Empirical Definition of Money: Components
Medium of
Exchange Store of Value Functions
Functions
Other deposits with RBI= (i) deposits of quasi govt and other financial institutions such as Primary Dealers' balances in the
accounts of foreign centrals banks and govts (iii)accounts of IMF, (iv) provident funds, gratuity and guarantee funds of RBI staff.
RBI or Empirical Definition of Money:
M0 (Reserve Money), M1(narrow money), M2, M3(broad money)
OR
Note in Circulation= = currency held outside RBI by the public , banks
treasuries etc.
➢ All the money held with Public, RBI as well as Government is called Total Stock
of Money.
➢ Money Supply is that part of this Total Stock of Money which is with public.
➢ By public we refer to the households, firms, local authorities, companies
etc.
➢ Thus, public money does not include the money held by the government
and the money held as CRR with RBI and SLR with themselves by
commercial banks.
➢ The reason of excluding the above two categories from money supply is
that this money held by the Government and RBI is out of circulation.
➢ In other way, this money has two components viz. Currency Component and
Deposit Component.
➢ Currency Component consist of all the coins and notes in the circulation,
➢ Deposit Component is the money of the general public with the banks,
which can be withdrawn by them using cheques, withdrawals and ATMs.
➢ Deposit can be either Demand Deposit or Time Deposit
RBI or Empirical Definition of Money:
Measures of Monetary and Liquidity Aggregates
5. Other Assets
Total Liabilities (1+2+3) Total Assets (1+2+3+4+5)
RBI or Empirical Definition of Money:
A Stylized Decomposition of Reserve Money
Net
Net RBI Net RBI Net Governme
RBI Credit RBI''s Non-
Credit to Credit to Foreign nt's
to Gross monetar Reserve Money
Year Central State Exchange Currency
Commerci Claims on y (M0)
Governme Governme Assets of Liabilities
al Sector Banks Liabilitie
nt nts the RBI to Public
s of RBI
0 1 2 3 4 5 6 7 1+2+3+4+5+6-7
1. No banking system
2. 100% reserve banking system:
banks hold 100% of deposits as reserves,
make no loans
3. Fractional reserve banking system
Banks and the Money Supply: An Example
Money supply
= currency + deposits = Rs.0 + Rs.100 = Rs.100
In a 100% reserve banking system,
banks do not affect size of money supply.
Credit Creation
CASE 3: Fractional Reserve Banking System
Credit Creation
Credit Creation
Credit Creation
Credit Creation
Credit Creation
Credit Creation
Credit Creation
Credit Creation
High Powered Money, Money Multiplier and Money Supply
Where,
Where, • M (or M3)= Money Supply
• C= Currency • H( or Mo)= High Powered Money
• D= Deposits • Cr= Currency to Deposit Ratio
• DD= Demand Deposit • RRr= RR/D = Required Reserve Ratio
• TD= Time Deposit • ERr=ER/D= Excess Reserve Ratio
• RR= Required Reserve • m= Money Multiplier
• ER= Excess Reserve
Credit Creation: Example-1
• If RRr is not binding, then any change in RRr will have little
to no effect. (only works if you significantly increase RRr!)
Factors affecting Money supply: Summary
• Bank credit
• Deficit financing
• Government Expenditure
• FII inflows
Demand for Money
Demand for Money
• There has been a secular decline in the velocity in the post-independence era reflecting
monetization ( maybe due to NAREGA)and commercialization of the economy.
• The decline in velocity accelerated in the aftermath of the global economic crisis reflecting the
weakness in credit demand and preference for liquidity
2. Keynesian Theory of Money and Interest
Keynesian Theory of Demand for Money
People hold money in two alternative form
1. Cash/Currency
2. Bonds or Securities,
_
P is fixed in entire Keynesian Models
2. Keynesian Theory of Money and Interest
Keynesian Theory of Demand for Money
MdT=f(Y) Transaction and Precautionary demand for
and MdP=f(Y) money is interest inelastic.
So, MdT=k(Y) k>0
and MdP=k(Y) k>0
k is constant proportion of money demand from Income for transaction
purpose in transaction demand for money and also the same in
precautionary demand for money.
MT d
Md
Y Y
Qty of money demand for transaction
Total Money Demand: Md=MTd+Mpd and precautionary purpose
=>Md=kY…………………(11)
2. Keynesian Theory of Money and Interest
Keynesian Theory of Demand for Money
Speculative Demand for Money
MdSp=f(i) i>0 and ΔMdsp/ Δi<0
=> Mdsp=Lo-h*I Speculative demand for money
h is constant proportion of money demand from interest rates
Real money demand depends upon real output and overall interest rates.
References:
• Handout supplied to you on Money:
Demand and Supply