To understand the money supply in the economy RBI uses monetary aggregates like M0, M1, M2, M3 etc.
The money supply is the total value of money available in an economy at a point of time.
In India, Reserve Bank of India (RBI), measures the money supply and publishes it on a weekly or fortnight basis.
What is meant by Monetary Aggregate?
Monetary aggregates are the measures of the money supply in a country.
Very often, the money supply in the economy is represented using a monetary aggregate called ‘broad money’, also denoted as M3.
There are also different other monetary aggregates.
From 1977 to 1998, RBI used four monetary aggregates – M1, M2, M3 and M4 – to measure money supply. The central bank also used the concept of Reserve Money.
However, measuring standards changed in 1998.
Now, the nomenclature is M0, M1, M2, and M3.
To distinguish new aggregates from old aggregates, RBI sometimes mentions new aggregates as NM0, NM1, NM2, and NM3.
Old Monetary Aggregates
From 1977, RBI has been publishing four monetary aggregates – M1, M2, M3 and M4 – besides the reserve money.
In the new system, reserve money is named M0.
M2 and M4 that included post office savings banks deposits. However, these are not very widely used now.
You can read more about the old monetary aggregates in the ClearIAS article on the money supply.
In this article, we mainly concentrate on the new monetary aggregates.
New Monetary Aggregates
The RBI has started publishing a set of new monetary aggregates following the recommendations of the Working Group on Money Supply: Analytics and Methodology of Compilation (Chairman: Dr. Y.V. Reddy) which submitted its report in June 1998.
The Working Group recommended compilation of four monetary aggregates on the basis of the balance sheet of the banking sector in conformity with the norms of progressive liquidity:
- NM0 (monetary base)
- NM1 (narrow money)
- NM2
- NM3 (broad money)
NM0 (Monetary Base or Reserve Money)
M0 is the sum of Currency in Circulation, Bankers’ Deposits with RBI, and ‘Other’ Deposits with RBI
Components of M0:
- Currency in Circulation
- Bankers’ Deposits with RBI
- ‘Other’ Deposits with RBI
Note: ‘Other’ deposits with RBI comprise mainly: (i) deposits of quasi-government and other financial institutions including primary dealers, (ii) balances in the accounts of foreign Central banks and Governments, (iii) accounts of international agencies such as the International Monetary Fund, etc.
NM1 (Narrow Money)
M1 is the sum of Currency with the Public, Demand Deposits with the Banking System, and ‘Other’ Deposits with RBI.
Components of M1:
- Currency with the Public
- Current Deposits with the Banking System
- Demand Liabilities Portion of Savings Deposits with the Banking System
- ‘Other’ Deposits with RBI
In other words, M1 = Currency with the Public + Demand Deposits with the Banking System + ‘Other’ Deposits with RBI
Significance of M1: M1 includes currency with the public and non-interest bearing deposits with the banking sector including that of RBI.
NM2
M2 is the sum of Currency with the Public, Current Deposits with the Banking System, Savings Deposits with the Banking System, Certificates of Deposits issued by Banks, Term Deposits of residents with a contractual maturity up to and including one year with the Banking System, and ‘Other’ Deposits with RBI.
Components of M2:
- Currency with the Public
- Current Deposits with the Banking System
- Demand Liabilities of Savings Deposits with the Banking System
- ‘Other’ Deposits with RBI
- Term Deposits of residents with a contractual maturity up to and including one year with the Banking System
- Certificates of Deposits issued by Banks
In other words, M2=M1+ Time Liabilities Portion of Savings Deposits with the Banking System + Certificates of Deposit issued by Banks + Term Deposits of residents with a contractual maturity of up to and including one year with the Banking System.
NM3 (Broad Money)
M3 is the sum of Currency with the Public, Current Deposits with the Banking System, Savings Deposits with the Banking System, Certificates of Deposits issued by Banks, Term Deposits of residents with the Banking System, Call/Term borrowings from ‘Non-depository’ financial corporations by the Banking System, and ‘Other’ Deposits with RBI.
Components of M3:
- Currency with the Public
- Current Deposits with the Banking System
- Savings Deposits with the Banking System
- Certificates of Deposits issued by Banks
- Term Deposits of residents with a contractual maturity up to and including one year with the Banking System
- ‘Other’ Deposits with RBI
- Term Deposits of residents with a contractual maturity of over one year with the Banking System
- Call/Term borrowings from ‘Non-depository’ financial corporations by the Banking System.
M3=M2+ Term Deposits of residents with a contractual maturity of over one year with the Banking System + Call/Term borrowings from ‘Non-depository’ financial corporations by the Banking System.
Significance of M3: M3 captures the complete balance sheet of the banking sector.
Liquidity Aggregates – L1, L2, and L3
In addition to the monetary aggregates, the Working Group had recommended compilation of three liquidity aggregates namely, L1, L2 and L3, which include select items of financial liabilities of non-depository financial corporations such as development financial institutions and non-banking financial companies accepting deposits from the public, apart from post office savings banks.
L1 – NM3 + All deposits with the post office savings banks (excluding National Savings Certificates).
L2 – L1 + +Term deposits with term lending institutions and refinancing institutions (FIs) + Term borrowing by FIs + Certificates of deposit issued by FIs.
L3 – L2 + + Public deposits of non-banking financial companies.
Central Bank Money vs Commercial Bank Money
In short, there are two types of money.
- Central bank money (M0)- obligations of a central bank, including currency and central bank depository accounts.
- Commercial bank money (M1-M3) – obligations of commercial banks, including current accounts and savings accounts.
In the money supply statistics, central bank money is M0 while the commercial bank money is divided up into the M1-M3 components.
How to measure Money Supply: Let’s make it simple!
Note: Demand Deposits include deposits in the Current Account and Savings Account (CASA). Term Deposits (or time deposits) include Fixed Deposits (FD) and Recurring Deposits (RD)
UPSC Question from this topic
[Question UPSC CSE 2020] If you withdraw Rs. 1,00,000 in cash from your Demand Deposit Account at your bank, the immediate effect on aggregate money supply in the economy will be
(a) To reduce it by Rs. 1,00,000
(b) To increase it by Rs. 1,00,000
(c) To increase it by more than Rs. 1,00,000
(d) To leave it unchanged
Answer: (d) To leave it unchanged
Learning Zone: M3 (broad money) is commonly used to measure the money supply. Among other things, this includes currency with public and demand deposits of banks. So, withdrawal of Rs.100,000 in cash does not make any difference to the aggregate money supply.
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