Model Answer
0 min readIntroduction
Money supply plays a crucial role in influencing macroeconomic variables like inflation, interest rates, and economic growth. The Reserve Bank of India (RBI) meticulously monitors and regulates the money supply to maintain price stability and foster sustainable economic development. The money supply isn’t a single figure; rather, it’s categorized into different measures, each representing a progressively broader definition of money. These measures, denoted as M0, M1, M2, M3, and M4, differ in their liquidity and the types of financial assets they include. Understanding these components is fundamental to comprehending monetary policy and its impact on the economy.
Components of Money Supply as per RBI
The RBI uses different aggregates to measure the money supply. These aggregates are classified based on their liquidity and the nature of the assets included. Here’s a breakdown:
- M0 (Reserve Money): This is the most liquid measure of money supply. It includes:
- Currency in circulation (notes and coins held by the public)
- Bankers’ deposits with the RBI
- ‘Other’ deposits with the RBI (e.g., State Government deposits)
- M1 (Narrow Money): This includes M0 plus:
- Demand deposits with the banking system (current and savings account balances)
- ‘Other’ deposits with the banking system (e.g., inter-bank deposits)
- M2: M1 plus:
- Post office savings deposits
- Time deposits with the banking system (fixed deposits, recurring deposits)
- M3 (Broad Money): M2 plus:
- Net time deposits of commercial banks
- Other deposits with banks
- M4: M3 plus:
- All deposits with Post Office Savings Bank (excluding time deposits)
The following table summarizes the components:
| Aggregate | Components |
|---|---|
| M0 | Currency in Circulation + Bankers’ Deposits with RBI + Other Deposits with RBI |
| M1 | M0 + Demand Deposits + Other Deposits with Banking System |
| M2 | M1 + Post Office Savings Deposits + Time Deposits with Banking System |
| M3 | M2 + Net Time Deposits of Commercial Banks + Other Deposits with Banks |
| M4 | M3 + All Deposits with Post Office Savings Bank (excluding time deposits) |
Why is Narrow Money 'Narrow'?
M1 is considered ‘narrow’ because it primarily includes the most liquid forms of money – currency and demand deposits. These are readily available for transactions. Compared to broader measures like M2, M3, and M4, M1 excludes less liquid assets like time deposits and post office savings.
The ‘narrowness’ stems from its limited scope. M2, M3, and M4 include assets that, while representing stored value, are not immediately available for spending. For example, a fixed deposit (time deposit) requires a specific maturity period before it can be withdrawn without penalty. Therefore, these broader measures represent a larger pool of purchasing power, but with a lower degree of immediate liquidity. M1 focuses solely on money directly used for transactions, making it a more precise, though limited, indicator of current spending capacity.
Furthermore, the inclusion of a wider range of assets in broader money aggregates reflects a more comprehensive view of the public’s overall wealth and potential spending capacity. The RBI uses these different measures to assess the overall monetary situation and formulate appropriate policy responses. For instance, a rapid increase in M1 might signal inflationary pressures, while a growth in M3 could indicate increased savings and investment.
Conclusion
In conclusion, the RBI employs a tiered system of money supply measures – M0 to M4 – each progressively encompassing a broader range of liquid and less liquid assets. M1, being the narrowest measure, focuses solely on the most liquid forms of money, making it a direct indicator of transactional capacity. Understanding these distinctions is crucial for analyzing monetary policy effectiveness and its impact on the Indian economy. The RBI continuously refines these measures to reflect evolving financial landscapes and ensure accurate economic monitoring.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.