Conti.

VI.6.4. 1. Basic Concepts

Theories of Money Supply
 
The Theory of Money Supply
Determinants Of Money
Money Supply Function and Velocity
Of Circulation Of Money
High Powered Money
Money Multiplier
Theory of Money Supply
 Money Supply
• The Money Supply refers to the total stock of
domestic means of payment held by the
Public.
• Here Public refer to individuals, business firms,
State and local government bodies, etc., all
categories of holders of money other than the
State Treasury, central bank and commercial
banks, all these being money creating
agencies.
 Conti.
• The cash balances held by the Central and State
Governments in the central banks and in
treasuries are not be considered as part of money
supply, since they arise out of the non-commercial
and administrative operations of the government.

• Definition : “ Money Supply refers to the amount

of money which is in circulation in an economy at
any given point of time.”
 Money Stock and Money Supply
• At a given point of time, the total stock of
money and total supply of money differ in an
economy. Stock of money held by the public is
considered as money supply and the rest that
lies with the money-creating agencies (i.e.,
central bank, commercial banks and state
treasury) is not a part of money supply.
 Money Supply – Stock as well as Flow Concept

• When money supply is viewed, at a point of time, it is

stock of money held by the public on a particular date.
• Money supply viewed over a period of time, it is flow
concept.
• Money Supply becomes a flow concept when unit of
money is spendable as well as re-spendable.
• The flow of money is measured by multiplying a given
stock of money held the public with the velocity of
circulation of money.
 Money Supply
Money Near Money
• Time Deposits
• Coins
• Deposits in Non Banking Financial
• Currency Notes Intermediaries such as –
• Demand Deposits 1) Post office saving Banks
2) Unit Trust
3) Building Societies
• Bills
1) Treasury Bills
2) Bills of Exchange
• Government Securities
1) Bonds
2) National Saving Certificates
• Equity
 Conti.

• Money bears 100 per cent liquidity.

• Near money lacks 100 percent liquidity.
• Money, held as cash balances earn no interest.
• Near money is an income earning asset.
 Approaches regarding measure of MS
• Traditional approach- currency and demand deposits.
• Chicago school’s Monetarist approach – currency,
demand deposits and time deposits.
• Gurley Shaw approach – currency, demand deposits,
time deposits, equity share, units of unit trust, etc.
( alternate liquid stores of value)
• Radcliffe or Liquidity approach – currency, all bank
deposits, deposits with other institutions, near
money and real assets, etc. ( general liquidity)
 RBI measure of money stock
• Before 1968 : M1 was measure of money
supply.
• After 1968 : Aggregate monetary resources,
fixed deposits were also added.
• Since 1977 : MI ,M2, M3 and M4.
 M1
M1 =
currency notes and coins with the people
+
Demand deposits of commercial and co-
operative banks
+
other deposits with RBI
• M2 :M1 + post office saving deposits are
included.
• M3 :M1 + time deposits of commercial
and cooperative banks.
• M4 :M3 + Total post office deposits.( Here,
Deposits in National Saving Scheme(NSS) and
National Saving Certificates(NSC) excluded)
 Money multiplier theory
m = M/H
M = m.H
(Total money supply = Money multiplier x High powered
money.

• Money multiplier (m) refers to the ratio of total money

supply(M) divided high powered money (H).
• H = Currency with the public, bank reserves (cash in
hand with banks and their balances with the central
bank)
 Changes in MS due to H and m

• RBI can alter the supply of High powered

money.

• It can change the value of money multiplier by

changing the legal minimum reserve ratio of
the commercial banks.
 Thank You

References :

1. Chapter : 5, Mithani D.M, Money, Banking, International

trade and Public Finance, Himalaya Publication, 2007.
2. Gupta Suraj B., Monetary Economics, S. Chand, 2012.
3. www.rbi.org.in