Money and Banking

Supply of Money

Money is something which is generally accepted as a medium of exchange, a measure of value, store of value and standard of delayed payments. Generally, we understand money supply as the sum total of currency with the people and demand deposits with the bank.

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Supply of Money

Money supply is a stock concept. It refers to the entire stock of money (of all types) held by the people of a country at a point of time. Money supply includes only that stock of money which is held by people, other than the suppliers of money themselves. In other words, money supply refers to the stock of money held by the public or those who demand money.

Money supply does not include stock of money held by the government, and stock of money held by the banking system of a country. The government and the banking system of a country are suppliers of money or are the producers of money. Hence, money held by them is not a part of the stock of money held by the people.

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Components of the Money Supply

Two main components of the money supply are:

  1. Currency (includes coins and notes)
  2. Demand deposits


  1. Coins: There were two types of coins – full bodied standard coins and token coin. Under Managed Currency System that prevails these days, full-bodied standard coins have little utility. Hence, these are no longer in circulation. Indian Rupee is neither a full-bodied standard coin nor is it a perfect token coin. Coins o the denomination of 50paisa, 25 paise, are token coins.
  2. Currency Notes: The government and the central bank of the country both issue the currency notes. In India, government issues One rupee note, while the Reserve Bank of India issues all other currency notes.

money supply

Source: istockphoto

Alternative Measures of Money Supply (Money Stock)

In India, the Reserve Bank of India uses four alternative measures of money supply known as M1, M2, M3 and M4. M1 is the most frequently used measure of money supply because its components are regarded as the most liquid resources. Below is the explanation of each measure:

(i) M1 = C + DD + OD

Here C stands for currency (paper notes and coins) detained by the public, DD signify demand deposits in banks and OD denotes other deposits in RBI which includes demand deposits of public financial institutions, demand deposits of foreign central banks and international financial institutions like IMF, World Bank, etc. Demand deposits can be taken out at any time by the account holders. Current account deposits are integrated with demand deposits.

However, we do not include savings account deposits in DD for the reason that there exists certain conditions on the amount and number of withdrawals.


(ii) M2 = M1 (detailed on top of) + saving deposits with Post Office Saving Banks

(iii) M3= M1 + Net Time-deposits of Banks

(iv) M4 = M3 + Total deposits with Post Office Saving Institute (excluding National Saving Certificate)

In fact, a great deal of discussion is still going on as to what constitutes money supply. Savings deposits of post offices are not a part of money supply for the reason that they do not provide a medium of exchange due to lack of cheque facility. In the same way, we do not count fixed deposits in commercial banks as money. As a result, M1 and M2 may be treated as measures of narrow money whereas M3 and M4 as measures of broad money.

M1 is used as the measure of money supply which is also called aggregate monetary resources of the general public. All the above four measures represent different degrees of liquidity, with M1 being the most liquid andM4 is being the least liquid. It is noteworthy here that liquidity means the ability to change an asset into money quickly and without loss of value.

Important Facts about Measures of Money Supply

  • The four measures of money supply represent different degrees of liquidity, with M1 being the most liquid and M4 being the least liquid.
  • M1 is widely used as a measure of money supply and it is also known as ‘aggregate monetary resources of the general public’.
  • M1 and M2  are generally known as narrow money supply concepts, whereas, M3 and M4 are known as broad money supply concepts.

Solved Example for You

Q: State the two components of the money supply

  1. Currency and term deposits
  2. Demand deposits with the banks
  3. Currency (notes and coins) with the people
  4. b and c both

Ans: The correct answer is option D. Money supply refers to the stock of money held by the people and those who demand money.

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