Increase in Money Supply

• 24 Jun 2020

According to recent Reserve Bank of India (RBI) data, the uncertainty caused by the Covid-19 pandemic has led to a surge in money supply.

Key Points

• RBI Data:
  
  • Since the end of March, 2020 currency held by the public increased by 8.2%.
  • M3 money supply (refer explanation below) increased by 6.7% in the first five months of 2020 compared with the same period last year. This is the highest growth in seven years.
  • Currency in circulation, which measures money with the public and in banks, has also surged.
  • However, the savings and current account deposits decreased by 8%. Gross capital formation also fell by 7% in the March, 2020 quarter.
• Reason:
  
  • The recent increase reflects higher cash withdrawals by depositors to meet needs during the lockdown period and also to safeguard themselves against salary cuts or job losses.
• Impact:
  
  • A rise in money supply usually is seen as a leading indicator of growth in consumption and business investments, but due to Covid-19 pandemic, the rise this time is unlikely to bolster either.
  • People have curtailed their discretionary spending as they’re not sure of their permanent income.
  • Lenders too are unwilling to take risks as slowing discretionary spending slows demand for manufactured and industrial goods.
• Money Supply:
  
  • The total stock of money in circulation among the public at a particular point of time is called money supply.
    
    • It needs to be noted that total stock of money is different from total supply of money.
    • Supply of money is only that part of total stock of money which is held by the public at a particular point of time.
  • The circulating money involves the currency, printed notes, money in the deposit accounts and in the form of other liquid assets.
  • RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4.
    
    • 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 organisations (excluding National Savings Certificates)
  • CU is currency (notes plus coins) held by the public and DD is net demand deposits held by commercial banks.
  • The word ‘net’ implies that only deposits of the public held by the banks are to be included in money supply.
    
    • The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of money supply.
  • M1 and M2 are known as narrow money. M3 and M4 are known as broad money.
  • These gradations are in decreasing order of liquidity.
    
    • M1 is most liquid and easiest for transactions whereas M4 is least liquid of all.
    • M3 is the most commonly used measure of money supply. It is also known as aggregate monetary resources.

Key Terms

• Gross capital formation refers to the ‘aggregate of gross additions to fixed assets (that is fixed capital formation) plus change in stocks during the counting period.’
  
  • Fixed asset refers to the construction, machinery and equipment.
• Currency in circulation includes notes in circulation, rupee coins and small coins.
• Currency with the public is arrived at after deducting cash with banks from total currency in circulation.

Source: TH