What are the Components of Money Supply?
Money Supply Definition: A money supply is a total of funds that circulates in an economy on any specific day. It includes all the notes, coins and demand deposits held by the general public on each day.
However, it does not include the funds kept with the government and financial institutions. This sum isn’t actually in circulation within the economy.
There are various important sources of money supply in the economy. They are the producers of funds who are liable for their distribution within the economy.
- The government that produces all the coins and therefore the one rupee notes
- The Federal Reserve Bank of India (RBI) issues all the paper currency and coins.
The money supply is the total quantity of cash within the economy at any given time.
Economists measure the cash supply because it’s directly connected to the activity happening all around us within the economy. The increase of funds raises the worth of the economy more.
Components of Money supply
These are the components of money supply –
- Currency with the people: Currency held by the general public is a component of the money supply, be it in terms of currency notes or coins. Currency is a medium of exchange for goods and services. The currency notes get issued by the government and accepted at their face value as payment.
- Demand deposits (DD) with banks: A DD account (DDA) is a checking account from which funds can get withdrawn at any time, without any advance notice. DDAs pay interest on the invested funds. The most common type of DDAs includes checking accounts and savings accounts.
- Time Deposits: These are interest-bearing and certificate of deposit (CD) accounts that feature a pre-set maturity date. The cash must remain within the bank account for the fixed term to earn the stated interest rate. Such bank accounts generally pay a higher rate of interest than a Daily or Current bank account. In short, a CD gives you higher returns than a Current bank account with significantly less risk than an investment. There can be two kinds of interest-bearing bank accounts –
- Fixed Deposits (FD) – A FD account requires a consistent amount for a hard and fast period of your time. FDs are the safest kind of investment.
- Recurring Deposits (RD)- Another variation to time deposit accounts is an RD account. In such bank accounts, the consumer puts in fixed amounts in small parts for an extended period.
While traditional investments like mutual funds and stocks can earn a better return, FDs and RDs require no effort after your initial investment.
What is the importance of the money supply?
As it increases, interest rates decrease. That leads to more investment which in turn puts extra funds within the hands of consumers. This process stimulates spending.
Who controls the money supply?
The central government bank controls the availability of currency by increasing or decreasing the monetary base. In India, the central bank is the RBI (Reserve Bank of India).
What is the source of the money supply?
The central banks of all countries are empowered to issue currency. Therefore, the central bank is the primary source in all countries. In effect, financial institutions enable the supply of funds while monetary authorities issue currency and serve as the source of all other sorts of monetary instruments including currency notes and coins.
What happens when funds increase?
An increase within the supply has multifaceted effects –
- Positive – Increased money supply lowers interest rates, spurring investment. It puts extra funds in the hands of consumers and thus stimulating spending.
- Negative – Opposite effects occur when the availability of cash falls or when its rate of growth declines.
Measures of Money supply
Measures of money supply in India were introduced by the Reserve Bank of India. It comprises 4 components –
- Reserve Money (M0):
It is also known as High-Powered Money, monetary base, base money etc.
M0 = Currency getting Circulated + Deposits with RBI + Other deposits with RBI.
It is the monetary base of the economy.
- Narrow Money (M1):
M1 = Currency with public + DDs with the Banking system (current account, saving account) + Other deposits with RBI
M2 = M1 + Savings deposits of post office savings banks
- Broad Money (M3)
M3 = M1 + Time deposits with the banking system
M4 = M3 + All deposits with post office savings banks
Importance of Money supply
The expansion of the circulating wealth is an essential component not only in accelerating the process of economic development but also in achieving price stability in the economy.
The money supply must increase to achieve the goal of development and a stable economy.
Thus, a rise in it has a significant impact on the pace of economic growth. When kept within reasonable bounds, it has the potential to stimulate economic growth. However, an excessive increase can have the opposite effect.
Thus, managing the money supply is critical for long-term economic growth.
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