The Most Important Components of Money Supply Laid Down by the Reserve Bank of India are listed below:
1. M1 Component of Money Supply:
This component of money supply refers to:
ADVERTISEMENTS:
(a) Currency, C, including paper money and metallic coins of all denominations,
(b) Net demand deposits, DD, including the savings deposits with the banking sector, and
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(c) Other Deposits, OD, including the deposits with RBI of quasi-government institutions such as Industrial Finance Corporation of India, State Finance Corporations, Industrial Development Bank of India, Agricultural Refinance and Development Corporation; deposits of International Monetary Fund (IMF) in Account No.2; deposits of foreign governments and foreign central banks and deposits of RBI’s Employees Co-operative Credit Societies. It is to be noted that other deposits with the Central Bank here do not include the deposits of government, commercial banks and deposits of IMF in Account No. 1. Thus,
M1 = Currency + Net Demand Deposits with Banks + Other Deposits with RBI.
ADVERTISEMENTS:
= C + DD + OD
M1 as a measure of money supply has been found highly useful by the monetarists in their theoretical analysis of income, price-level and money supply. Another argument that goes in favour of M1 is the exclusion of the time deposits from money supply.
Many scholars believe that time deposits should not be included in money supply due to their non-uniform maturities and their resemblance with non-money financial assets.
Exclusion of time deposits from M1 however, makes it a narrow measure of money supply.
2. M2 Component of Money Supply:
ADVERTISEMENTS:
This component of money supply is devised to include post office savings deposits in the M2 component of money supply. Thus,
M2 = M1 + Post Office Savings Deposits
Note that the time deposits remain excluded even from M2 making it a narrow measure of money supply. In order of liquidity, M2 ranks next to M1.
3. M3 Component of Money Supply:
M3 is the sum of M1 and the time deposits. Hence, it represents a broader measure of money supply and is known as the Aggregate Monetary Resource (AMR). Thus,
M3 = M1 + Time Deposits
= M1 + TD
M3 as a measure of money supply is shown preference not only by RBI but also by economists such as Milton Friedman. Even Chakravarty Committee favoured M3 to M1 as a measure of money supply.
The need for evolution of M3 was perhaps intentional. RBI might have had an intention to impart a high level of liquidity to the time deposits at some point of time. The fact may be evidenced by its recent policy of allowing the commercial banks to grant cash credit up to 90% of the time deposits to the depositors.
Under it, a depositor can enjoy credit facility to the tune of 90% of the time deposit and can continue with his time deposit which he otherwise had to discontinue in the event of cash requirement.
Time deposits, under the circumstances, do no longer resemble the other non- money financial assets, and hence, should be included in money supply. Inclusion of time deposits in M3 makes it a broader measure of money supply. In liquidity, M3 ranks below Ml and M2.
4. M4 Component of Money Supply:
M4 is the sum of M3 and the Post Office Savings Deposits. It represents broader concept of money supply. Thus,
M4 = M3 + Post Office Savings Deposits
While M2 is an extension of M1 M4 is an extension of M3. M2 and M4 are recent concepts. In liquidity, M2 ranks above M4. RBI periodically provides estimates of money supply in terms of M1, M2, M3 and M4 to indicate varying degrees of liquidity of different components of money supply. If arranged in descending order of liquidity, the four components will follow the order M1, M2 M3 and M4.
While Ml and M2 provide the narrow measures of money supply, M3 and M4 provide its broader measures.
We have seen that money supply is a stock concept. Volume of money supply at a point of time would depend on magnitudes of the constituents of a particular component (M1 or M2 or M3 or M4) used by the economy’s monetary system at that point of time.
The four components have their relative merits and demerits, a comprehensive discussion of which is beyond the scope of this text. Emphasis has, however, rested on the use of M1 or M3 to measure money supply at a point of time.
Prior to 1978, RBI concentrated on the use of M1 for the purpose but thereafter, it has shifted to M3 (AMR) as a measure of money supply. Hence, volume of money supply now depends on the magnitudes of the constituents of M3 namely, currency (c), demand deposits (DD), other deposits (OD) and time deposits (TD).
In the same way, changes in the volume of money supply over a period of time depend on changes in these constituents of M3. Magnitudes of the constituents and changes therein, both depend on policies of monetary institutions. We will return to monetary policy.