Money Supply means the total amount of money and other liquid assets in a country's economy in circulation. Banking regulators regulate the money supply through policy and regulatory actions in order to maintain economic stability. Money supply data is collected and published because it influences the price level, inflation, the exchange rate, and the business cycle. “Supply of Money” is one of the important concepts in the UPSC/IAS 2023 Economy syllabus which is discussed in this article in detail.

What is Supply of Money?

• The total stock of money circulating in an economy is referred to as the supply of money.
• In layman's terms, it is defined as currency in circulation plus deposits in commercial banks.
• The supply of Money consists of the following:
  • The total currency circulating in the public
  • Non-bank deposits with a commercial bank
• Currency in circulation is the total value of all currency (coins and paper currency) issued by the Reserve Bank of India minus the amount withdrawn by it. It is a significant liability on a central bank's balance sheet.
• Currency in circulation (currency with the public) includes the following:
  • Currency notes and coins with the public
  • Cash in hands with banks
• Money supply plays a crucial role in the determination of price level and interest rates.
• The growth of the money supply helps in the acceleration of economic development and price stability.
• Credit control policies imposed by a country's banking system aid in determining the total supply of money.
• The monetary base and the money multiplier ultimately determine the money supply.
• Monetary policy has an effect on the money supply as well.
  • The expansionary policy raises the total supply of money in the economy faster than usual, while contractionary policy raises the total supply of money more slowly than usual.
  • Expansionary policies are used to combat unemployment, whereas contractionary policies are used to slow inflation.

Effects of Money Supply on Economy

• The money supply, or total cash present in a country's economy, is bound to have an impact on market economics. As a result, any change in the demand and supply of money will cause a change in the market.
• A rise in the money supply will be reflected in lower interest rates and prices of commodities and service.
• A decrease in the money supply will result in higher interest rates and prices, with a corresponding increase in bank reserves.
• A similar effect occurs in the business. As the price level falls due to increased money supply, the business output will rise to accommodate people's increased spending.
• As a result, the money supply and money demand have a direct impact on the macroeconomics of a country's market.

Components of Money Supply

Currency

• Currency is a significant component of a country's money supply. As previously stated, the government issues currency in two forms: coins and paper currency. As a result, the money supply via currency can also be divided into:
  • Paper Currency/Notes - The government and the Reserve Bank of India have control over the production of currency notes. The government produces only one-rupee paper currency in the country, while the RBI produces all other currency notes.
  • Coins - Coins, India's second form of currency, are produced in two varieties: token coins and standard coins, also known as full-bodied coins. Under the current currency system, full-bodied currency coins have little value. The token coins have a face value of 50 paise and25 paise.

Demand Deposits

• Demand deposits are a type of commercial bank deposit that serves as a non-confidential fund.
• When a country's economy includes these accounts, they are considered money.
• The working mechanism of such deposits is similar to that of a checking account, where withdrawals from the fund can be made without notice.

Measures of Money Supply

• The RBI publishes figures for four different measures of money supply, namely M1, M2, M3, and M4. They are defined as below:
  • M1 = CU + DD
  • M2 = M1 + Savings deposits with Post Office savings banks
  • M3 = M1 + Net time deposits of commercial banks
  • M4 = M3 + Total deposits with Post Office savings organizations (excluding National Savings Certificates)
• where CU is public currency (notes and coins) and DD is net demand deposits held by commercial banks. The term 'net' implies that only public deposits held by banks are to be included in the money supply.
• M1 and M2 are referred to as narrow money.
• M3 and M4 are referred to as broad money.
• M1 is the most liquid and easiest to transact with, whereas M4 is the least liquid.
• M3 is the most commonly used money supply measure. It's also referred to as aggregate monetary resources.

Reserve Money (M0)

• Reserve money is also referred to as central bank money, monetary base money, base money, or high-powered money.
• Reserve money is all of the cash in the economy and is denoted by M0.
• It includes the following components:
  • Currency with the public
  • Other Deposits with the RBI
  • Banks' cash reserves held with themselves
  • Banks' cash reserves held with the RBI
• Cash Reserves are classified into two types: Required Reserves (RR) and Excess Reserves (ER).
  • RR is the reserves that banks are legally required to keep with the RBI.
  • Excess Reserves are all reserves in excess of RR.
  • ER is held by banks, whereas RR is held by the RBI.
  • Banks hold the ER to cover currency drains, i.e., currency withdrawals by depositors.

Factors Affecting Money supply

Monetary Base

• When the reserve moneychangers, the money supply changes in the same direction. This means that as more reserve money enters the system, the money supply expands and vice versa.
• In most countries, the size of the monetary base is determined by the central bank.
• The monetary base includes vault reserves as well as currency in circulation outside of banks.
• Central banks may alter reserve requirements in order to alter the monetary base.

Money Multiplier

• Money Multiplier is the ratio of Narrow Money (M1) or Broad Money (M3)to Reserve Money.
• A money multiplier method is used to demonstrate the maximum amount of broad money that commercial banks could create for a given fixed amount of base money and reserve ratio.

Supply Curve of Money

• The money supply curve depicts the relationship between the quantity of money supplied and the market interest rate, with all other supply determinants remaining constant.
• The money supply is solely determined by the central bank and is unaffected by interest rates.
• As a result, the money supply curve is vertical at the quantity of money supply, rather than upward or downward sloping.
• Since the central bank has control over the money supply, it can take actions to increase or decrease the money supply. Changes in the money supply cause interest rates to fluctuate.

Conclusion

Money supply has a significant impact on a country's economy. The inflation of commodity prices, as well as their demand and supply, alter the supply of money. In economics, the money supply influences interest rates and cash flow throughout the country.