3.5. The Supply of Money: Various Measures

In a modern economy, money consists mainly of currency notes and coins issued by the monetary authority of the country. In India, currency notes are issued by the Reserve Bank of India (RBI), which is the monetary authority in India. However, coins are issued by the Government of India.

Money is vital for any economy as it serves as a medium for transactions. In modern economies, money primarily consists of physical forms like currency notes and coins. In India, the RBI is responsible for issuing currency notes, while coins come from the Government of India. This distinction is important as it highlights the role of central authority in controlling what is considered legal money.

Think of money like a well-organized store. The RBI is like the manager who decides what items (currency) are available for customers (the public) to use for their purchases. Just as customers trust the store to provide quality products, people trust the RBI to issue reliable currency.

Apart from currency notes and coins, the balance in savings or current account deposits held by the public in commercial banks is also considered money since cheques drawn on these accounts are used to settle transactions. Such deposits are called demand deposits as they are payable by the bank on demand from the account-holder. Other deposits, e.g. fixed deposits, have a fixed period to maturity and are referred to as time deposits.

Money isn't just physical cash; it also includes what people have in their bank accounts. When individuals have funds in checking or savings accounts, they can easily access this money whenever they need it. These funds are known as demand deposits. In contrast, funds in fixed deposits are less accessible since they are locked in for a specific period. Understanding the different types of deposits helps us grasp how money functions in the economy.

Consider demand deposits like water in a tap that you can turn on whenever you are thirsty. You can access that water immediately. Time deposits are like ice cubes kept in the freezer. They can be turned into water (money) later but only after waiting for some time. While the water is readily available, the ice requires planning to use.

The value of the currency notes and coins is derived from the guarantee provided by the issuing authority of these items. Every currency note bears on its face a promise from the Governor of RBI that if someone produces the note to RBI, or any other commercial bank, RBI will be responsible for giving the person purchasing power equal to the value printed on the note. Currency notes and coins are therefore called fiat money. They do not have intrinsic value like a gold or silver coin. They are also called legal tenders as they cannot be refused by any citizen of the country for settlement of any kind of transaction.

Fiat money is currency that a government has declared to be legal tender, meaning it must be accepted if offered in payment of debt. Its value comes not from physical commodities but from trust in the issuer, in this case, the RBI. This is important to understand because it highlights how societal acceptance and governmental backing create value in money.

Imagine a club with exclusive membership cards. The cards themselves are not valuable, but the promise from the club to provide services makes them valuable. Similarly, paper currency holds value because the government backs it, allowing it to be used for trade and transactions.

Money supply, like money demand, is a stock variable. The total stock of money in circulation among the public at a particular point of time is called money supply. RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4. They are defined as follows: 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).

Money supply is a stock variable, meaning it shows the total amount of money available at any given point in time. The RBI categorizes money supply into different measures: M1 is the most liquid and includes currency and demand deposits. M2 includes M1 plus some savings deposits, while M3 adds time deposits, making it broader. M4 includes M3 and additional deposits from the Post Office. Understanding these measures gives insights into how money circulates in the economy.

Think of M1, M2, M3, and M4 as different levels of a water reservoir. M1 is the top layer of water that is most accessible for use immediately. M2 adds another layer of water that can be accessed with some effort, while M3 and M4 include water that takes more time to access but is still part of the overall reservoir.

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