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Subject ECONOMICS

Paper No and Title 11: Money and Banking

Module No and Title 3 : Measurement of money

Module Tag ECO_P11_M3

TABLE OF CONTENTS
1. Learning Outcomes
2. Introduction
3.Measurment of Money in India
3.1 COMPONENTS OF MONEY STOCK IN INDIA
3.1.1 CURRENCY (C)
3.1.2 DEPOSITS ( D )

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3.1.3 CURRENT ACCOUNT

DEPOSITS
3.1.4 FIXED AND RECURRING DEPOSITS
3.1.5 SAVING ACCOUNT DEPOSITS
3.1.6 POST OFFICE DEPOSITS
4. Classification of bank deposits by RBI
4.1 Demand Deposits
4.2 Time Deposits
4.3 Net Demand Deposits

5. Working Group Of The RBI Monetary Aggregates

5.1 THE FIRST WORKING GROUP OF THE RBI (1961 – 67/68)
5.2 SECOND WORKING GROUP OF THE RBI (1977-1998)
5.3 THIRD WORKING GROUP – 1997
6. Monetary and Liquidity Aggregates
6.1 Monetary Aggregates
6.2 Liquidity Aggregates
7. Simple Sum versus Weighted Monetary Aggregates
8. Summary

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1. Learning Outcomes
After studying this module, you shall be able to

· Learn about the issues in the measurement of money, particularly with reference to India.
· Know how to define the components of money stock in India.
· Identify the Monetary Aggregates as they have evolved over the years and the reasons for
the changes.
· Evaluate the difference between simple sum and weighted monetary aggregates.

2. Introduction
In view of the fact that the supply of money has an integral impact on the economy, key variables
like income, prices, wages, employment, rate of interest, and balance of payments, we need to
measure it precisely. For this, we will first have to settle on a theoretical definition of money,
only after that we can identify empirically the things that serve as money in an economy. Then,
the stock of moneys of various kinds at a particular point of time can be computed
The question of an appropriate measure of money is widely debated around which financial
assets are to be included in the measure. Those theories which stress on the transaction motive
of holding money favour a narrow measure while those theories that treat money as an asset for
store of value emphasised on a broader measure of money. This makes money not a fixed entity
but a question of preference and judgement. Money acts as a means of payment, a store of
value, a unit of account and is highly liquid with fixed nominal value. It may, or may not be
providing a rate of interest .As a matter of fact, different financial and real assets could be
arranged in a descending order with reference to their liquidity .Currency and Demand deposits
are the most liquid assets as they are the medium of exchange. Time deposits and government
bonds are liquid assets, but cannot be converted into the medium of exchange without incurring
some cost. At the bottom of the liquidity continuum lie automobiles, real estate etc., which can be
liquidated at a short notice only at a substantial cost. Accordingly, several measures of money are
thus possible, each successively dropping a point lower on the liquidity scale, in differentiating
between money and all other assets. There is thus, no unique definition of money. For policy
purposes it could be defined as the set of liquid financial Assets, the variations in the stock of
which could have an impact on aggregate Economic Activity.
In view of the above ambivalence associated with the proper
measure of money, monetary authorities all over the world provide alternate measures of
money, leaving the choice to specific situations .The classification of monetary

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aggregates used by most central banks is based either

on the functional characteristics of monetary assets or the institutional distinction
between banks and other financial intermediaries. Innovations in banking practices and
products are likely to affect the efficacy of the aggregates. As a statistical construct,
money should reflect assets with monetary characteristics and specific liquid liabilities of
a particular set of financial intermediates.

3. MEASUREMENT OF MONEY IN INDIA

At the outset, two things need to be noted before we discuss any measure of money supply
.First is the supply of Money refers to its stock at any point of time. Second, the stock of money
always refers to the stock of money held by the PUBLIC, where PUBLIC includes all economic
units.(households firms, institutions, all local authorities ,non-bank financial institutions ,non-
Departmental public sector undertakings, foreign central Banks and Govt. And the IMF who hold
a part of Indian money in India in the form of Other Deposits (OD) of the RBI) They are all the
demanders or holders of money and are separated from the produces or suppliers of money like
the Banking system (RBI and all Banks which accept demand deposits DD) and the Govt.
(Central Govt. and state Govts). Such a separation of suppliers and demanders of money is
essential for monetary analysis and policy formulation.
3.1 COMPONENTS OF MONEY STOCK IN INDIA
Any narrow definition of money of money would include those assets which serve as a medium
of exchange .This should include currency C which can be directly used to pay for payment of
goods and services and chequable deposits with the banks which are used through the use of
cheques to pay for the good or service
M = C+DD+OD
3.1.1 CURRENCY (C)
In India, currency consists of paper currency notes as well as coins. Paper currency is in the form
of Reserve Bank of India currency notes of the denomination of Rupees Two and above (Rupees
five, ten .twenty, fifty, hundred, five hundred and one thousand) They are liability of the Reserve
Bank of India In addition, there are small amounts of Government of India rupee one notes and
coins along with metallic coins of smaller denomination .They are direct monetary liability of the
Government of India. However they are put into circulation by the RBI as an agent of the central
government. The RBI does this by holding stocks of government currency on hand and by
maintaining full convertibility of this currency into the rest of the country’s currency and vice
versa They along with currency notes are however, not convertible into assets like gold or silver,

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3.1.2 DEPOSITS ( D )

The institutions supplying these deposits can be Banks, or Post offices, or Non-Bank Financial
Intermediaries. However, only the first two are considered in Monetary Aggregates as their
liabilities alone serve as a means of payment. We will now consider various kinds of Bank
Deposits.

3.1.3 CURRENT ACCOUNT DEPOSITS

Current account deposits do not earn any rate of interest and are payable on demand, transferrable
by means of cheques and are usually used by businessmen for their day to day transactions.

3.1.4 FIXED AND RECURRING DEPOSITS

Fixed Deposits are deposits made for a particular period of time and they earn a rate of interest
according to the time period for which they are kept with the banks. They are not Chequable or
transferrable as a means of payment and are considered as near moneys to be used only in a
broader definition of money.

Recurring Deposits are also not chequable where a compound interest is earned on the amount
that is paid at periodic intervals into the account.

3.1.5 SAVING ACCOUNT DEPOSITS

These deposits are held by individuals for transaction purposes, and have a certain amount or
proportion which cannot be withdrawn, or the entire amount is not chequable .They earn a rate of
interest on the amount which is not withdrawn.

3.1.6 POST OFFICE DEPOSITS

Post Office Deposits also have a component of saving, fixed and recurring deposits. Post Office
Saving deposits are similar to saving deposits at banks but they are withdrawn able through
withdrawal slips and there is a restriction on the number of withdrawals and the amount of a
single withdrawal. They are more liquid than fixed deposits at banks but less liquid than deposits
at commercial banks.

4. Classification of Bank Deposits by RBI

The R.B.I reclassifies current saving and fixed deposits of the banks into Demand and Time
deposits

4.1Demand deposits

Deposits which are withdraw able on demand and transferable by cheque. With this criterion,
current account deposits are put under demand deposits, and that proportion of saving account
deposits which are withdrawn or used for transaction purposes are also put under demand
deposits.

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4.2 Time deposits

Deposits which are not withdrawn and on which an interest is earned. On this basis, Fixed and
recurring deposits are easily classifiable under time deposits under this criterion.

As for saving account deposits that portion of saving account deposits which are actually
withdrawn are put under Demand Deposits and that portion of saving account deposits which is
not withdrawn and on which interest is earned is classified under Time Deposits.

4.3 NET DEMAND DEPOSITS

The demand deposits at a bank consist of both deposits made by the public, as well as
interbank deposits. However, since our concern is only with deposits made by the public,
we subtract interbank deposits from total deposits to get net demand deposits with
banks.

5. Working group of the RBI Monetary Aggregates

The RBI has constituted 3 working groups to constitute the money supply measures.
5.1 THE FIRST WORKING GROUP OF THE RESERVE BANK OF INDIA (1961 – 67/68)

Had a single measure of Ms consisting of a narrow definition of money including public holding
of free currency, and Demand Deposits
M = C + DD.
It emphasized the role of money as a liquid asset as well as medium of exchange. From 1967 –
68 to April 1977, RBI started publishing Aggregate Monetary Resources with inclusion of near
S
money TD .

AMR = M + TD
AMR= C + DD + TD.
5.2 SECOND WORKING GROUP OF THE RESERVE BANK OF INDIA (1977-1998)

From April 1977, 4 measures of money supply M1 , M 2 , M 3 , M 4 were published which ranked

assets in varying (decreasing) degree of liquidity with an extended institutional coverage of post
offices and cooperative Banks which by then, had started a wide network to supplement
commercial banks in their deposit & credit coverage, particularly after nationalization of Banks.

M1 = C+ DD + OD
M 2 = M1 + POSD

M 3 = M1 + net time Deposits of Banks

M 4 = M 3 + Total Deposits with the post office saving organisation excluding national saving
Certificates, including post office Time, recurring & cumulative Time Deposits. Where DD were

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the net demand deposits of both scheduled and non-scheduled

commercial banks as well as the net demand liabilities of state cooperative Banks.

5.3 THIRD WORKING GROUP – 1997

1. In the earlier period, the economy had limited financial Assets like currency, or deposits with
Banks so that the balance sheet of Banking Institutions provided the basis of for monetary
aggregates,
2. The financial markets were undeveloped, the rates of interest were administered and there
were restricted external transitions.
3. With financial liberalization, the markets and the rates of interest were free, and developed.
4. Due to financial innovations, there was an array of financial Assets available like certificates of
deposits issued by banks and other financial institutions, commercial papers, and foreign
securities. The availability of these assets had an impact on aggregate demand.
5. Now, apart from depository corporations, like commercial and cooperative banks, there are
development financial institutions & Non-Bank financial corporations performing intermediary
functions, there was a blurring of distinctions in the operations among these institutions. This
affected the efficacy of the existing second working group monetary aggregates because they
included only the liabilities of the banking sector and hence did not adequately reflect the state of
liquidity in the economy. It is for this reason that the second working group monetary aggregates

M1 ® M 2 were not progressive in terms of liquidity.

6. There was delay in the receipt of information from the non-scheduled segment of the
commercial banks and the cooperative sector as also the post offices which affected and delayed
the monthly flow of data rendering M2 & M4 less significant for policy purposes. As a result, only
M1 and M3 were being used.
7. These Postal deposits issued by Post offices could not be included in a monetary aggregate
because the postal department is a part of general government and hence the producers of
money.
8. With Banks now investing in domestic debt & Equity instruments and foreign assets, their
returns are affected by fluctuations in interest rates & exchange rates. However, there is no
mechanism for this change in valuations.
9. There is a need to make the methodology of compilations according to international standards
consistent with UN system of Accounts.
10. With deregulation, Non-Bank, Non-government share in total financial assets have been
increasing, as also their intermediating liabilities hence the share of non-depository corporations

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have been increasing .This has to be incorporated in Broader

liquidity measures which would be empirically related to overall Economic activity.
11. SECTORISATION OF THE ECONOMY
The Third working group divided the Economy into 5 sectors consisting of
(1) Households
(2) Non-Financial Commercial sector,
(3) General Government
(4) Financial Corporations comprising of
i) The banking sector consisting of the RBI and the banking system in India
ii) The other financial corporation sector
(5) The rest of the world sector.
While the First and the second working group had divided it into 3 sectors
(1) Private or commercial sector subdivided into
(a) rest of the domestic sector including public non-government sector undertakings
(b) foreign sectors
(2) The Banking sector
(3) Government sector.

12. RESIDENCY ISSUE

The Third working group has also raised the Residency issue where Residency relates to the
country in which the holder has a center of economic interest. The NRls hold their deposits in
India in 2 forms (1) NRI Rupee deposits, (2) NRI Repatriable foreign currency Deposits. If the
currency and Demand deposits held by the NRIS are repatriable, like the FCNR (B) and
Resurgent India Bonds (RIBs), deposits they would have more relevance for Balance of
Payments & International capital flows, than domestic transactions
Therefore these should be regarded as external liabilities to be netted out from the foreign
currency assets of the Banking system. The foreign currency liabilities of Banks have thus been
identified explicitly in the new aggregates enabling an accurate compilation of Banks ‘net foreign
assets. However, Non Resident Rupee Deposits should be integrated into the domestic financial
system.

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The Second working Group had included both Rupee Deposits

as well as FCNR deposits in their Monetary Aggregates but the Third working Group included
only the Rupee Deposits excludes the Non Resident Repatriable foreign currency fixed Deposits

treated as External liabilities.4.

6. Monetary and Liquidity Aggregates

A major Differentiation made by the Third working Group Financial Aggregates was between
Monetary Aggregates and Liquidity Aggregates not on the basis of the attributes of the
instruments themselves, as on the nature and functions of institutions issuing such instruments.
The Monetary Aggregates considers only the Liabilities of Depository Corporations which
includes following Institutions
(a) RBI
(b) Banking system consisting of
(i) SBI and its subsidiaries
(ii) Nationalised banks
(iii) regional rural banks
(iv) Commercial banks in Private sector and foreign banks
(v) Cooperative banks
However, over time, the share of non-depository corporations in total financial assets has been
growing; their liabilities are good substitutes for broad money and are empirically related to
overall economic activity or prices. Therefore in a broader concept of liquidity, total assets held by
the public that are issued by all financial intermediaries both banks as well as non-banks should
be included.
Some of the assets suggested by the Third working Group are post office deposits, Public
Deposits, Term borrowings and certificates of Deposits of Financial Institutions, Public Deposits
with Non-Banking Financial Corporations.
Some countries included commercial papers and Treasury bills too in liquidity Aggregates
however they are not used in India because they are not held by the public.
However, the following instruments like call term funding from Non-Bank financial Institutions
could be included in monetary aggregates.
Hence particular exclusions would be foreign currency fixed Deposits by Non-Residents (FCNR
(B)] deposits as well as Money market mutual funds (MMMFS) which could be classified under
non depository financial corporations but because of balance sheet restrictions on their
functioning, they are included neither in monetary nor liquidity aggregates.

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The Third working Group differentiated Monetary Aggregates

from other Financial Aggregates not with respect to their attributes. But with respect to the nature
and functioning of the institutions which supply these assets,
The basic distinctions between Monetary Aggregates, and liquidity Aggregates is that the former
includes the monetary-liabilities of RBI and the Banking system that is, of Depository corporations
while the latter includes financial liabilities of non-depository financial corporations) such as
Development financial institutions (DFI) and Non-Banking Financial corporations accepting
deposits from the Public apart from Post office saving Banks.
Even through Financial Institutions may issue financial assets similar to Bank Deposits; we
cannot treat them as money unless the Financial institutions are similar to banks in Services.
Such assets should be included in liquidity measures.
The Third working Group published 4 monetary Aggregates on the basis of the banking sector
balance sheet in norms of progressive liquidity and 3 Liquidity Aggregates and 1 financial sector
Survey
M0 Monetary base
M1 narrow money
M2 & M3 broad money

6.1 MONETARY AGGREGATES.

WEEKLY DATA
M0 = currency in circulation
+ Bankers Deposits with the RBI
+ other Deposits with the RBI
M1 = Currency with the public
+ Demand deposits with the Banking system including both current deposits or well as
Demand liabilities portion of saving deposits.
+ other deposits with the RBI.

M 2 = M1 + Time Liability portion of saving Deposits with the Banking system.

+ certificates of Deposits issued by banks.
+ Term deposits (excluding FCNR (B) deposits with a contractual maturity of upto and
including one year with the Banking System.

M 2 = currency with the Public

+ current Deposits with the Banking System

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+ Saving Deposits with the Banking System

+ Certificates of Deposits issued by Banks

+ Term deposits excluding FCNR (B) deposits with a contractual maturity £ 1 yr.

+ other deposits with the RBI.

M 3 = M 2 + Terms Deposits (excluding FCNR (B) deposits with a contractual maturity of >1
year with the Banking System
+ call borrowings from non-depository financial corporations by the Banking System.

6.2 LIQUIDITY AGGREGATES

L1 = M 3 + All Deposits with the post office saving Banks (excluding National Saving
Certificates).

L 2 = L1 + Term deposits with Term lending Institutions and Refinancing Institutions ( Fls )
+ Term borrowing by Financial Institutions
+ Certificates of Deposits issued by Financial Institutions

L3 = L 2 + Public Deposits of Non-Banking Financial companies

SIMPLE SUM VERSUS WEIGHTED MONETARY AGGREGATES

7. Simple sum versus Weighted Monetary Aggregates

The aggregates discussed above are all simple sum monetary aggregates because they assume
perfect substitutability among their components. That is, currency with public is added to bank
deposits to get broader monetary aggregates. Simple sum aggregates implicitly assign equal
weights to all components which is inconsistent with economic theory. Assuming perfect
substitutability among unsubstitutable or imperfect assets, for example, C and TD in M3, they
treat the two together which is against economic intuition and empirical evidence .simple sum
measures distort monetary aggregates and are accounting measures not suitable for meaningful
economic analysis.
An alternative is the weighted monetary aggregates which give weights to the moneyness of an
asset. These weights reflect value shares and are derived from the interest return on the
component vis-a-vis a benchmark instrument held purely for investment earnings. By this logic, C
& DD have largest weight because they have no rate of interest. Higher liquidity and low interest
are also given larger weights in comparison with instruments with higher interest.

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Criticism of weighted monetary aggregates is that weights

depend on choice of benchmark instrument and assumes a normal relationship between short
term and long term rates of interest which may not hold in practice. Also, liquidity being inversely
related to the rate of interest on a financial instrument is eroded by financial innovations.Weighted
Monetary Aggregates also however have conceptual and empirical problems particularly in the
Institutional setting of developing and emerging market economies. That is in India, there is
deficiencies of operationalisation rather than conceptualisation.

5. Summary
· There is no unique definition of money. The empirical measure of money depends on
which characteristic of money we would like to stress.
· The money supply refers to its stock held at a point of time by the public. The demanders
of money are separated from the suppliers of money.
· The 3rd working group monetary and liquidity aggregates reflect the changes in the
financial system.
· Simple sum monetary aggregates are theoretically inferior to weighted monetary
aggregates but the latter are operationally difficult to construct.

ECONOMICS Paper 11: Money and Banking

Module 3 : Measurement of Money