Money supply and it's classification

WHAT IS MONEY SUPPLY?

The supply of money ia a stock at a particular point of time. It is synonymous with terms as "money stock", "quantity of money" etc. 
The supply of money at any moment is the total amount of money in the economy.

DETERMINANTS OF MONEY SUPPLY

The determinants of money are:-

1) The Required Reserve Ratio- It is an important determinant of money supply. An increase in the required reserve ratio reduces the supply of money with commercial banks and a decrease in required reserve ratio increases the money supply.

2) Public's Desire To hold Currency and Deposits- It also determines the money supply.If people are in the habit of keeping less in cash and more in deposits with the commercial banks, the money supply will be large. On the contrary, if people do not have banking habits and prefer to keep their money holdings in cash, credit creation by banks will be less and the money supply will be low.

3) High-Powered Money- The current practice is to determine the money supply in terms of high-powered money. It is the sum of commercial bank reserves and currency held by the public. The supply of money varies directly with change in high-powered money.

RBI CLASSIFICATION OF MONEY SUPPLY

According to RBI, money supply can be classified under four measures. They are:-

1) M1- This is the first measure of money supply. It consists of:
             (a) Currency with the public which includes notes and coins of all                         denominations in circulation excluding cash on hand with banks;
               (b) Demand deposits with commercial and cooperative banks
                (c) Other deposits with RBI which include current deposits of foreign central banks and financial institutions

RBI characterises M1 as NARROW MONEY.

2) M2- This is the second measure of money supply. It consists of:
              (a) M1 + post office savings bank deposits.
     The majority of people in rural and urban India have preference for post office deposits from the safety viewpoint than bank deposits.

3) M3- It is the third measure of money supply. It consists of:
             (a) M1+ time deposits with commercial and cooperative banks,excluding inter-bank time deposits.

RBI calls M3 as BROAD MONEY.

4) M4- It is the fourth measure of money supply and consists of:
     (a) M3+ total post office deposits comprising time deposits and demand deposits as well.

This is the broadest measure of money supply.

CONCLUSION

Among the 4 measures, M3 is of special significance. It is M3 which is taken into account in formulating macroeconomic objectives of the economy every year. Since M1 is narrow money and includes only demand deposits of banks alongwith currency held by the public, it overlooks the importance of time deposits. That is why RBI prefers M3 which includes total deposits of banks and currency with the public .

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