Money

IBS B
Money is anything that is generally accepted as
a means of payment in the settlement of
transactions
Money supply
Money supply refers to the stock of money at a point
in time.

sources of money supply

They are the producers of the money and are responsible for its
distribution in the economy. These are
 The government who produces all the coins and the one rupee
notes
 The Reserve Bank of India (RBI) which issues all the paper currency
 Commercial banks as they create the credit as per the demand
deposits

❖ RBI publishes data on the alternative measures of money supply

❖ Narrow supply of money – until 1967-68
❖ Medium of exchange function of money, only currency and demand deposits
held by the public were included.
❖ Broader measure of money/aggregate monetary resource – 1967-68
❖ Store of value function of money, time deposits of commercial banks held by the public,
in addition to currency and demand deposits.
 Money Supply

Narrow Money (M1) = Currency with the Public + Demand

Deposits with the Banking System + 'Other' Deposits with
the RBI.

M2=M1 + Savings Deposits of Post-office Savings Banks.

Broad Money (M3) = M1 + Time Deposits with the Banking

System.

M4 = M3 + All deposits with Post Office Savings Banks

(excluding National Savings Certificates).
INDIA MONEY SUPPLY DATA

Indicator Data Period

Money Supply 43249 INR Billion
Sep/20
M1 | 587.979 B USD
Money Supply 44427 INR Billion
Nov/20
M2 | 603.994 B USD
Money Supply 179111 INR Billion
Nov/20
M3 | 2435.051 B USD

https://take-profit.org/en/statistics/money-supply-m1/india/
Theory of determinants of Money Supply

 The money supply is determined exogenously by

the central bank.
 The money supply is determined endogenously by
changes in the economic activities which affects
people’s desire to hold currency relative to
deposits, the rate of interest, etc.
➢ Determinants of money supply are both exogenous
and endogenous which can be described broadly
as: the minimum cash reserve ratio, the level of
bank reserves, and the desire of the people to hold
currency relative to deposits. The last two
determinants together are called the monetary base
or the high powered money.
 Banks are not merely purveyors of money, but
also manufacturers of money.
 Banks create deposits via lending.
 Instead of giving loans in cash, banks issue cheque
against the name of the borrowers.
 The borrower is free to draw upon his money by
drawing cheques to the banks. The people who
receive the cheque deposit them in another bank.
 The bankers know that the amount of money that
the depositors withdraw soon returns to the bank.
Process of credit creation

 Banks have two types of assets—legal minimum cash reserve ratio,

and loans and advances to the public (to earn profit).
 There is no leakage of cash (i.e., no drainage of cash outside the
banking system). Also only cheque transaction takes place.
 Mr. ‘A’ deposits Rs. 1,000 in the United Bank of India.
 With a required reserve ratio of 10 p.c., the UBI keeps Rs. 100 as cash
reserve and can lend Rs. 900 to Mr. B.
 Mr. B uses this money to buy goods valued at Rs. 900 from Mr. C
who deposits the same in the State Bank of India.
 The SBI has now a deposit of Rs. 900, new legal cash reserve of Rs. 90
and new loans of Rs. 810.
 The SBI now gives loans to customer Mr. D who uses it to buy goods
from seller Mr. E who deposits his cheque of Rs. 810 in the Bank of
Baroda, and so on.
 The process of lending of 90 p.c. of new deposits is repeated till the
final deposit becomes too small to create any fresh loans.
The total increase in money supply (∆M) due to a deposit of Rs. 1,000
∆ M = Rs. 1,000 + 900 + 810 + 729 … + ∆ M = Rs. 1,000 [1 + 0.9 + (0.9)2 + (0.9)3 +
…. + (0.9)n]

The geometric series in the brackets can be summed up to give:

∆M = Rs. 1,000 (1/1 – 0.9)
∆M = Rs. 10,000

A cash reserve of 10 p.c., a deposit of Rs. 1,000 results in a Rs. 10,000 increase in
money supply.
The credit multiplier is 10.
This is the mechanism of deposit multiplication through the process of credit
creation.
credit multiplier is:
∆ M = ∆ D. 1/r
Or, ∆M/∆D = 1/r
where ∆ D means the original deposit and r represent the legal minimum cash
reserve ratio.
The smaller the ‘r’, the higher is the value of credit multiplier.
If ‘r’ is raised, the credit or deposit multiplier will be weaker.
In short, banks can create deposits through lending much more than their original
amount of deposits.
.
 Excess reserves—the difference between actual reserve and required
reserve—form the basis of monetary expansion through bank lending.
 Banks have to maintain legal reserve requirements stipulated by the
central bank.
 Any bank that holds money more than legal reserve ratio can make
loans. This amount may be called excess reserves
D = 1-r
 where r is the minimum cash reserve. The value of the third deposit will
be the value of the second deposit, d, minus the legal cash reserve on the
second deposit, i.e.,
d (1 -r) = d2
 The value of the fourth deposit will be equivalent to the value of the third
deposit, d2, minus the required reserve on the third deposit, i.e.,
d2 (1 – r) = d3
 and that of the fifth deposit
d3 (1 – r) = d4
 The sequence of this infinite but diminishing chain of deposit creation and,
hence, change in total money supply, ∆M, after n deposits resulting from a
deposit of Re. 1, is:
∆ M = 1 + d + d2 + d3 + d4 + … + dn -1
 Since r < 1, the sum of this geometric progression taken to an infinite number
of periods may be found by the formula
∆M = 1/1 – d
d = 1 – r. Then,
∆M = 1/1 – 1 + r = 1/r
 If the primary deposit be ∆ D
∆M = ∆D. 1/r
This effect is known as money multiplier

 If r = 1/10 (i.e., 10 p.c.), the value of bank multiplier becomes 10, i.e., an
increase in initial deposit of Rs. 1,000 causes total deposits or money supply to
rise by Rs. 10,000.
 The initial deposit has “multiplier” effect on money supply. The credit
multiplier is then defined as the total increase in money supply divided by
the increase in deposit, i.e.,
∆M /∆D = 1/r
 The deposit multiplier (or money multiplier) is equal to the reciprocal of
minimum cash reserve ratio.
 If r = 0.2, the credit multiplier would be 5. This means money supply increases
by Rs. 5 for each one rupee increase in deposit.
Limitations of credit creation

 Leakage of Cash:
In the process of credit expansion, the basic assumption is that there is no
leakage of cash, i.e., the amount lent by one bank is immediately deposited in
another bank. If the borrowers do not deposit the entire amount of sanctioned
loans. A part of the loaned amount is deposited. This will cause multiplier
effect to become weaker.
 Preference for Liquid Cash:
The credit creating capacity of banks greatly depends on the desire of the
public to hold cash. If people use more cash rather than cheque, the banks
will be left with a smaller amount of credit deposit and, consequently, the
process of credit creation will slow down.
 Central Bank’s Influence:
The credit creation formula that the value of the deposit multiplier
depends on the value of cash reserve ratio is determined by the central bank
of a country. If it is raised by the central bank, credit creating power of the
commercial banks will be smaller and, hence, the multiplier will be weaker.
 Business Conditions:
 Credit creation depends upon the business conditions prevailing in an
economy. If business conditions look unfavourable, people will take fewer
loans and advances from the commercial banks. Thus the total volume of
money supply will be smaller. Larger credit expansion is possible only in
periods of prosperity.
Despite these limitations, there is no doubt that commercial banks can and do
create credit and thus increase the supply of money in an economy.

 The larger the reserve-deposit ratio (r), the
smaller the money multiplier.
 The larger the currency-deposit ratio (c), the
smaller the money multiplier currency- deposit
ratio, c.
 Smaller the c, the smaller the proportion of the high-
powered money that is being used as currency
 Monetary policy refers to the policy of the
central bank with regard to the use of
monetary instruments under its control to
achieve the goals specified in the Act.

 The Reserve Bank of India (RBI) is vested with

the responsibility of conducting monetary
policy. This responsibility is explicitly
mandated under the Reserve Bank of India
Act, 1934.
 Policy Rates
Policy Repo Rate : 4.0 %
Reverse Repo Rate : 3.35 %
Marginal Standing
: 4.25 %
Facility Rate
Bank Rate : 4.25 %

 Reserve Rates

CRR : 3%
SLR : 18 %
It is the rate at which the Reserve Bank is ready to buy or rediscount bills of
exchange or other commercial papers.
4.25 %
 4%
6.25%
 Reverse Repo Rate: The (fixed) interest rate at
which the Reserve Bank absorbs liquidity, on
an overnight basis, from banks against the
collateral of eligible government securities
under the LAF.
 Current reverse repo rate : 3.35 %
3%
18 %
  Moral Suasion

It implies to pressure exerted by the RBI on the Indian banking

system without any strict action for compliance of the rules. It is a
suggestion to banks.

 Direct Action

Under this method the RBI can impose an action against a bank. If
certain banks are not adhering to the RBI's directives, the RBI may
refuse to rediscount their bills and securities. Secondly, RBI may
refuse credit supply to those banks whose borrowings are in
excess to their capital. Central bank can penalize a bank by
changing some rates. At last it can even put a ban on a particular
bank if it dose not follow its directives and work against the
objectives of the monetary policy.
 Publicity

The Central Bank (RBI) publishes various reports stating

what is good and what is bad in the system. To help
commercial banks to direct credit supply in the desired
sectors.

 Credit Rationing

Central Bank fixes credit amount to be granted. Credit is

rationed by limiting the amount available for each
commercial bank
 Change in MS
 IR
 MS to public….
 Opportunity cost of holding money for
public….
 Expansionary monetary policy
 Contractionary monetary policy
 Economy is in recession
 Expansionary policy will be
adopted
 The increase in money supply,
state of liquidity preference or
demand for money remaining
unchanged, will lead to the fall
in rate of interest.
 At a lower interest there will be
more investment by
businessmen. More investment
will cause aggregate demand
and income to rise. This implies
that with expansion in money
supply LM curve will shift to the
right
 Economy is in inflation
 Contractionary policy - liquidity in the
banking system should be reduced.
Decrease in money supply.
 Rise in the interest rate and fall in the
income level.
 Reduction in investment demand and
consumption demand
 Reduce money supply through open
market operations - selling bonds or
government securities and in return gets
currency funds from those who buy the
bonds.
 The higher CRR implies that the banks
have to keep more cash reserve with the
Central Bank
 MS
 Y
 Imports….
 Trade deficits…..
 Ms
 I … - exchange rate …
 Y … - exchange rate …
 P … - exchange rate …
 Expansionary monetary policy
 Contractionary monetary policy
Thank you