Money supply and Reserve Money of India

Money supply

The Reserve Bank of India (RBI) is the central bank of our country. It manages the monetary system of our country. It has classified the money supply of our country into four components.

They are :

M1 = Currency with the public. It includes coins and currency notes + demand deposits of the public. M1 is also known as narrow money ;

M2 =   M1 + post office savings deposits ;

M3 = M1 + Time deposits of the public with the banks. M3 is also known as broad money ; and

M4 =   M3 + total post office deposits.

Note : Besides savings deposits, people maintain fixed deposits of different maturity periods with the post office.

Reserve Money

Reserve Money (RM) may be considered as Government money. (In this context, the Reserve Bank of India (RBI) is also taken as Government). Reserve money is the cash held by the public and the banks.

It is composed of

C = currency with the public in circulation

OD = other deposits of the public with the RBI (OD) (The public regard their deposits with the RBI as cash or money) and

CR = cash reserves of banks. Cash reserves are composed of two parts :- They are (1) cash reserves with banks themselves and (2) Bankers deposits with RBI.

Thus,

Reserve Money (RM) = C+ OD + CR

We may note that the simple theory of money supply states that supply of money (M) is an increasing function of reserve money (RM). In other words, as Reserve Money changes, supply of money also changes.

The Reserve money is also called high powered money on account of its great influence on money supply.

Fiat Money : Currency notes in circulation are normally referred to as fiat money. For example, one Rupee notes issued by the Government of India is Fiat money.

The notes issued by the RBI are usually referred to as bank notes. They are in the nature of promissory notes.