Money and Financial Markets

PART-I (Money)

Chapter 3

Supply of Money

Bibhuti Ranjan Mishra VNIT, Nagpur 1-

1. Introduction

Money is used as a means of payments and accepted for the settlement

of debts.
Supply of money – stock of money held by the public in spendable
forms.
Public – Individuals and business firms excluding banks.
Stock as well as a flow

Bibhuti Ranjan Mishra VNIT, Nagpur

2. Constituents of Money Supply

a. Traditional View:

Currency money + Bank money

b. Modern View

Currency money + Bank money + Time deposits + Financial Assets

Currency Money:
Legal tender money called as High Powered Money
1 rupee coin issued by MoF.
Rest coins issued and managed by RBI.
RBI Act, 1934- 40% of the total asset should consist of gold coins, bullions and foreign securities
with the value of Rs. 40 crores.
RBI Act, 1956,- minimum reserve system replaces proportional reserve system. [foreign securities –
Rs. 400 cr., Gold coins and bullions – Rs. 115 cr.
RBI Act, 1957 – Reserve should be at least worth Rs. 200 cr., and gold value – Rs. 115 cr.

Bibhuti Ranjan Mishra VNIT, Nagpur

Determinants of currency money

1. Volume of Transactions
2. Nature of Trade
3. Method of Payment
4. The Price level
5. Banking Habits
6. Distribution of Income
7. Other factors
Bank Money
Total money supply: primary HPM and secondary or bank money
Currency (2/3rd) and Demand deposits (1/3rd)

Bibhuti Ranjan Mishra VNIT, Nagpur

3. Approaches to the definition of money
supply
Traditional Approach
Money Supply= currency with public + demand deposits with the commercial banks.

Monetarist Approach
Money Supply= currency with public + demand deposits + time deposits.

Gurley and Shaw Approach:-

Money Supply = currency with public + demand deposits + time deposits + liabilities of
non banking intermediaries (saving band deposits, shares, bonds etc.)

Redcliffe Committee Approach:-

Money supply= cash + all bank deposits + deposits with other institutions + near money
assets.

Inaccurate measure as degree of liquidity varies across institutions.

Bibhuti Ranjan Mishra VNIT, Nagpur

4. Velocity of Money

Transaction velocity of money



Income velocity of money


Velocity of money (Income < transaction)

Theory of Velocity of money

 or 
Assuming, 
But, 
One time change in P does not affect V.
Real income will effect V positively.
Interest rate and V are directly related.
Expected inflation influences interest positively, thereby affecting V positively .

Bibhuti Ranjan Mishra VNIT, Nagpur

Factors influencing velocity of money

Payment system
Money supply
Regularity of income
Value of money
Propensity to consume
Credit facilities
Distribution of income
Volume of trade
Liquidity preference
Frequency of transactions
Size of population
Business conditions
Means of transport and
Business Integration
communication

Bibhuti Ranjan Mishra VNIT, Nagpur

5. Theory of money supply

Money Supply Model


Definition and Ratios


 Or 
 Or 
 
Or 

Bibhuti Ranjan Mishra VNIT, Nagpur

 Money multiplier

Substitute (6) into (5) and use the result in (3)

Substitute (4) and (7) into (8),

Equation (9) can be solved for DD to give,

Here,  is known as the deposit multiplier. Now substitute (10) and (4) into (2),

The expression  in equation (11) is known as the money multiplier (m).

Bibhuti Ranjan Mishra VNIT, Nagpur

 Money Supply Function


Where,
 is the value of money. 
 is the rate of interest. 
 is the real income. 
 is monetary policy. 
 is the seasonal factors. 

Bibhuti Ranjan Mishra VNIT, Nagpur

Determinants of Money Supply

1.

1. Monetary Base
2. Money multiplier
3. Reserve ratio
4. Currency Ratio
5. Confidence in Bank money
6. Time-deposit ratio
7. Value of money
8. Real income
9. Interest rate
10. Monetary policy
11. Seasonal Factors

Bibhuti Ranjan Mishra VNIT, Nagpur

6. Money Supply in India






High Powered Money


New Series
Since 1997-08, we follow the methodology of Work Group on money Supply: Analytics of
methodology and compilation” (June 1998).
 differs from old  by a magnitude of consisting of FCNR (B) deposits and RIBs, and banks
pension and provident funds.

Significance of Money Supply Measures

As an economic variable, .
As a policy controlled variable, .
Bibhuti Ranjan Mishra VNIT, Nagpur