However, if there are sufficient net capital inflows accruing from the capital account of the balance of payments, then deficit in current account (i.e., negative NX) can be met by these capital inflows. Accessed Jan. 13, 2020. Accessed Jan. 13, 2020. In other developed countries, since 1957 Reserve Bank of India follows Minimum Reserve System of issuing currency. As a result of Central Bank intervention to meet the current account deficit and to maintain the exchange rate money supply in the economy decreases. money supply is endogenous in m odern econom ies. This report can easily provide the impact details of the money supply that is essential for the economic growth of India. For example, in April 2008, M1 was $1.371 trillion and M2 was $7.631 trillion (both seasonally adjusted). Concept of Money Supply and Its Measurement: Factors Determining Money Supply: RBPS Analysis. Under this system, minimum reserves of Rs. On the other hand, in the developing countries banking has not developed sufficiently and also people have not acquired banking habits and they prefer to make transactions in currency. The purchase of foreign exchange (US dollars) from the foreign exchange market by the Reserve Bank led to the increase in money supply in the Indian economy that caused inflationary pressures. In the open economy there is free flow of goods and services through trade with foreign countries. The reason why money supply M2 has been distinguished from M1 is that saving deposits with post office savings banks are not as liquid as demand deposits with commercial and cooperative banks as they are not chequable accounts. First, this will reduce rupee currency in circulation which will cause reduction in money supply in the economy. In other words, there will be deficit in current account of the balance of payments. Accessed Jan. 13, 2020. But these Rs. The U.S. money supply is all the physical cash in circulation throughout the nation, as well as the money held in checking accounts and savings accounts. Secondly, the imports of goods will increase aggregate supply of goods in the economy which will tend to lower prices. "Credit Cards Are Commonly Used to Buy Goods and Services Are Credit Card Transactions or Credit Card Debt Included in Demand Deposits or the Money Supply? If Reserve Bank wants to manage it and tries to maintain it at Rs. Thus. changes in the money supply. As we first discussed in Chapter 29, the money supply in the U.S. economy is controlled by the Federal Reserve. The number of rupee notes and coins in circulation. When in an open economy with flexible exchange rate regime there is deficit in overall balance of payments (i.e., on both current and capital accounts), it means that capital inflows are insufficient to bridge the gap in the balance of payments, then, in case of India, this has to be met with use of foreign exchange reserves by the Reserve Bank of India. Change in the high-powered money is decided and controlled by Reserve Bank of India, the money multiplier determines the extent to which decision by RBI regarding the change in high-powered money will bring about change in the total money supply in the economy. There are two possible links between budget deficit and growth in money supply. The money supply roughly includes both … That is why they are called legal tender. Reserve Bank of India classifies factors determining money supply into the following categories: (a) Government borrowing from the banking system; (b) Borrowing of the private or commercial sector from the banking system; (c) Changes in net foreign assets held by the Reserve Bank of India caused by changes in balance of payments position; and. If there is such a situation, there is no impact on the money supply. Thus, the relationship between money supply and the high-powered money is determined by the money multiplier. However, this excludes contributions made by the public to the national saving certificates. M1 is the sum of currency held by the public (i.e., currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions); M2 includes M1 along with savings accounts. (a) Meaning of Money Supply (D2010): The supply of money means the total stock of money (paper notes, coins and demand deposits of bank) in circulation which is held by the public at any particular point of time. When Reserve Bank of India pays foreign exchange (e.g. Expansion of the money supply can cause inflation but not always. When external balance does not exist the Central Bank will either go on losing foreign exchange reserves which it cannot do so for long or it will be gaining foreign exchange reserves which also poses a problem as it leads to increase in money supply and causes inflationary pressures in the economy. Some economists therefore call it ‘The H Theory of Money Supply’. Use precise geolocation data. First, different components of money supply have been distinguished on the basis of the different functions that money performs. Therefore, RBI intervened only to a small degree and let the rupee appreciate to some extent. In this case there will be no impact of deficit in current account balance of payments on money supply in the economy. Kimberly Amadeo is an expert on U.S. and world economies and investing, with over 20 years of experience in economic analysis and business strategy. There is, however, an important difference. Board of Governors of the Federal Reserve System. Share Your Word File Apply market research to generate audience insights. Whereas Government can borrow more or less compulsorily from Reserve Bank of India, the private sector cannot do so from the commercial banks. Now, an important question is what determines the size of money multiplier. As a result, demand for money or loanable funds increases which, given the supply of money, causes interest rate to rise. The money supply is the most liquid measure of money supply as the money included in it can be easily used as a medium of exchange, that is, as a means of making payments for transactions. Currency-Deposit Ratio of the Public and Money Multiplier: However, in the real world, with the increase in reserves of the banks, demand deposits and money supply do not increase to the full extent of deposit multiplier. It includes ‘money held by public only’. First, when following an expansionary fiscal policy the government raises its expenditure without financed by extra taxation and thereby causing a budget deficit, it will tend to raise interest rate. That is, when there is a decrease in currency reserves with the banks, there will be multiple contraction in demand deposits with the banks. However, if the economy is in the grip of a severe depression, the risk of causing inflation through monetisation of budget deficit and consequent growth in money supply is not much there. A healthy growth of an economy requires that there should be neither inflation nor deflation. For example, in April 2008, M1 was $1.371 trillion and M2 was $7.631 trillion (both seasonally adjusted). The Federal Reserve doubled the money supply to end the 2008 financial crisis. It also added $4 trillion in credit to banks to keep interest rates down., Some may have concerned that the Federal Reserve's massive injection of money and credit would create inflation. It identify and analyzes macro economic factors, money supply and profers the significance and impact of macro-economic factors on money supply. Money Supply's Intersection With Inflation . When banks lend money to the Government, they create credit. Coins and one-rupee notes represent Government’s currency liabilities to the public. It may further be noted that these days paper currency issued by Reserve Bank of India (RBI) are not fully backed by the reserves of gold and silver, nor it is considered necessary to do so. As a result, our foreign exchange reserves have substantially gone up, which have resulted in the issue and expansion of rupee currency in circulation. Therefore, it is believed that for monetary analysis and policy formulation, a single measure of money supply is not only inadequate but may be misleading too. However in India after 50 years of independence and economic development the proportion of bank deposits in the money supply has risen to about 50 per cent. According to the modern economic thinking the magnitude of currency issued should be determined by the monetary needs of the economy and not by the available reserves of gold and silver. It may be noted that demand deposits are fiduciary money proper. Michael Boyle is an experienced financial professional with 9+ years working with Financial Planning, Derivatives, Equities, Fixed Income, Project Management, and Analytics. What Is the Money Supply? In addition to the items of money supply included in measure M1, in money supply M3 time deposits with the banks are also included. Hence various measures of money supply are prepared to meet the needs of monetary analysis and policy formulation. On the basis of small cash reserves of currency, they are able to create a much larger amount of demand deposits through a system called fractional reserve system which will be explained later in detail. What do i do? However, if borrower of bank A withdraws Rs. The control of money supply is an essential tool in conducting monetary policy within the monetary targeting framework. To prevent sharp depreciation of rupee the RBI intervened in the foreign exchange market by selling dollars in the market. 100 increase in cash reserves with the banks, there will be expansion in demand deposits of the banks by Rs. Federal Reserve Bank of New York. 80, bank B will create demand deposits of Rs. the high-powered money) in India and the contraction of the money supply with the public. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. If instead currency reserves held by the banks increase, this will not change the money supply immediately but will set in motion a process of multiple creation of demand deposits of the public in the banks. 48 per US dollar, EH is the increase in capital inflows. Under this scheme the Central Government has issued Market Stabilisation Bonds. 45 per US dollar. Thus, cheques make these demand deposits as a medium of exchange and therefore make them to serve as money. Economics projectplease follow me on instagramhttps://www.instagram.com/dheeraj_bajaj_/for further project of class 12 That is, one rupee of high- powered money kept as bank reserves gives rise to much more amount of demand deposits. Board of Governors of the Federal Reserve System. To do so more rupee currency is printed by RBI to pay for US dollars purchased by it. The FIIs started selling Indian equity and bonds and converting rupee into US dollars. Thus. As a result, money supply (rupee currency) in the economy will decline. Since the two require different types of policy measure by the Central Bank, they clash with each other. In fact, the RBI has no fixed target for maintaining exchange rate of rupee at any level and instead its policy is to allow exchange rate of rupee to fluctuate within a band. With this, at the existing exchange rate of Rs. When it does so the Central Bank prints domestic currency to pay for the bonds it purchases. It is worth noting that Reserve Bank of India and Government are producers of the high-powered money and the commercial banks do not have any role in producing this high-powered money (H). 72 and keep Rs. THE IMPACT OF MONEY SUPPLY ON ECONOMIC GROWTH IN NIGERIA (1981-2010) ABSTRACT The study examined the impact of money supply on economic growth in Nigeria. This situation is depicted in Fig. For instance, for purchase of food grains by the Food Corporation of India, the banks give a large amount of loan to the Government. This is done to neutralize the monetary impact of large accumulation of net foreign exchange assets with RBI caused by capital inflows on a large scale. If Not, Why Doesn’t the Definition of the Money Supply Include Them? Thus, changes in high-powered money are the result of decisions of Reserve Bank of India or the Government which owns and controls it. Currency notes in circulation issued by the Reserve Bank of India. 8 as reserves with it (80x 10/100 = 8). order) of the Government. 1000 assuming that no leakage of cash to the public occurs during the process of deposit expansion by the banks. In August 2004 foreign exchange reserves has risen to US $ 119 billion. Features of the money supply: It includes money help from the public only. This separation of producers of money from the users of money is important from the viewpoint of both monetary theory and policy. On the other hand, if time-deposits component of money supply measure M3 which serves as a store of value is increasing rapidly, it can be validly concluded that people are planning to save more and accordingly consume less. Inflation is the greatest headache of a developing economy. It may be noted that other deposits of Reserve Bank of India constitute a very small proportion (less than one per cent). When the supply of high-powered money (i.e., reserve money) H increases; 2. Opposite result would follow when there is a net surplus in the balance of payments of a country. With this agreement, Market Stabilisation Scheme (MSS) has been started. 16.1. Deposits with the banks are broadly divided into two types: demand deposits and time deposits. The Board of Governors of the Federal Reserve System. However, these other deposits of Reserve Bank of India include the following items: (i) Deposits of Institutions such as UTI, IDBI, IFCI, NABARD etc. The money multiplier which we denote by m is the ratio of total money supply (M) to the stock of high-powered money, that is, m = M/H . The ratio of reserves to deposits is known as the reserve ratio. This led to the increase in demand for dollars resulting in appreciation of US dollar and depreciation of Indian rupee. This unpredictable variation in money multiplier in the short run affecting money supply in the economy prevents the Central Bank of a country from controlling exactly and precisely the money supply in the economy. This means during the process of creation of demand deposits by banks, some currency is leaked out from the banks to the people. There must be controlled expansion of money supply if the objective of development with stability is to be achieved. However, since loans from the banks can be easily obtained against these time deposits, they can be used if found necessary for transaction purposes in this way. Credit Cards Are Commonly Used to Buy Goods and Services Are Credit Card Transactions or Credit Card Debt Included in Demand Deposits or the Money Supply? Let us explain the two components of money supply at some length: In order to arrive at the total currency with the public in India we add the following items: 1. Changes in the foreign exchange assets held by the Reserve Bank can also bring about a change in the money supply. If there are no capital inflows, then to maintain the exchange rate at OR, the Central Bank of the country has to supply foreign exchange equal to LK out of the reserves held by it. "Credit and Liquidity Programs and the Balance Sheet." According to the standard concept of money supply, it is composed of the following two elements: Before explaining these two components of money supply two things must be noted with regard to the money supply in the economy. If Not, Why Doesn’t the Definition of the Money Supply Include Them?" Several definitions of money supply have been given and therefore various measures of money supply based on them have been estimated. Since the Government and the banks produce or create money for the use by the public, the money (cash reserves) held by them are not used for transaction and speculative purposes and are excluded from the standard measures of money supply. A major objective of RBI is to control inflation. The working group on monetary reforms under the chairmanship of late Prof. Sukhamoy Chakravarty recommended its use for monetary planning of the economy and setting target of the growth of money supply in terms of M3. Full backing of paper currency by reserves of gold prevailed in the past when gold standard or silver standard type of monetary system existed. Therefore, money multiplier is less than the deposit multiplier. Develop and improve products. However, commercial banks are producers of demand deposits which are also used as money like currency. Thus RBI did not intervene sufficiently to prevent the appreciation of rupee between Oct. 2006 and Oct. 2007. We explain below the role of these two factors in the determination of money supply in the economy: The high-powered money which we denote by H consists of the currency (notes and coins) issued by the Government and the Reserve Bank of India. The two important determinants of money supply as described in equation (1) are (a) the amounts of high-powered money which is also called Reserve Money by the Reserve Bank of India and (b) the size of money multiplier. These four concepts of measures of money supply are explained below. This also adds to the money supply with the public because when banks lend, they create credit. Thus. In the developed countries such as USA and Great Britain deposit money accounted for over 80 per cent of the total money supply, currency being a relatively small part of it. Money supply is one of the important macroeconomic variables. Now, under a variable exchange rate regime as it exists today, if exchange rate is allowed to adjust freely, rupee will rise to Rs. The Government also borrows from the ordinary commercial banks. This implies that the supply of foreign exchange exceeds demand for it. We thus see that the currency-deposit ratio, which we denote by k, is an important determinant of the actual value of money multiplier. This is the narrow measure of money supply and is composed of the following items: DD = Demand deposits with the public in the commercial and cooperative banks. It may also be noted that apart from balance of payments on current account foreign exchange reserves or assets may also come through either foreign aid or deposits in Indian banks by NRI or foreign direct investment made by foreign companies in India. It should be noted that if the foreign exchange reserves are used to import goods in short supply, it will help in lowering inflation rate for two reasons. It has been intervening in the foreign exchange market to prevent large appreciation of rupee. (d) Government’s currency liabilities to the public. The value of rupee which was around Rs. Select personalised content. For example, in recent years there has been a large-scale inflow of foreign exchange through investment made by foreign companies and NRI deposits in India. Does the Federal Reserve or U.S. Treasury Print Money? per US $) is measured on the Y-axis and number of US dollars are measured on the X-axis. How QE Allows Central Banks to Create Massive Amounts of Money, Four Tools Central Banks Use to Control the World Economy, The Real Owner of the US Debt Will Surprise You, The Secret Symbols on the Back of the Dollar. Secondly, money supply always refers to the amount of money held by the public. Share Your PPT File, supply explains how a given supply of high-powered money (which is also called monetary base or reserve money) leads to multiple expansion in money supply through the working of money multiplier. This creation of new currency for financing the deficit of the Central Government Budget is known as monetization of deficit. Therefore, there has been a decline in RBI’s credit to the Government in the last about 10 years. The deficit in current account balance requires the Central Bank to sell foreign exchange from its reserves to prevent the depreciation of domestic currency (that is, to maintain the exchange rate constant). 10 in cash from the bank and issues cheques of the remaining borrowed amount of Rs. (iii) Cash reserves on hand with all banks. It is the latter course of action that was adopted by Reserve Bank of India before 1995 when government’s fiscal deficit was high and a good part of it was monetised by it. For example, demand deposits, credit card and currency are used by the people primarily as a medium of exchange for buying goods and services and making other transactions. 3. k, that is, currency-deposit ratio of the public. We explain the sterilization operations by RBI later. 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