Monetary Base,Correlation between M0, M1, M2 and M3,Money Supply vs Monetary Base

                                 

Monetary Base / Reserve Money Monetary Base (M0):

• Monetary base is the total liability of RBI which is actually the money created /printed in the economy by RBI.
• As per the RBI Act, the only liability of the Issue Department is 'Notes in Circulation' but If we analyse the balance sheet of RBI, the major liabilities are :

Monetary base formula:

Notes in circulation + Reserves with RBI .

• So, the monetary base (or M0) is the total amount of a currency that is either in general circulation or in the form of commercial bank deposits held in the central bank's reserves.
• This measure of the money supply is not often cited since it excludes other forms of non-currency money that are prevalent in a modern economy.
• It is also said to be High powered money or powerful money as it refers to the currency that has been issued by the Government and Reserve Bank of India.

WHY  M0 (Monetary base) is LIABILITY ON RBI :

• If citizen produces a currency note to RBI the latter must pay her value equal to the figure printed on the note. 
• Similarly, the deposits are also refundable by RBI on demand from deposit-holders. 
• These items are claims on RBI and hence are considered to be the liability of RBI.

Correlation between M0(Monetary base), M1, M2 and M3:

• In a modern economy, M0 is transformed to M1, M2 and M3 through the process of Money multiplier (explained in blog) which is more relevant to common man.
• Money supply ie M3 can be higher than monetary base as the M0 is transformed from M0 to M3 through the process of money multiplier.

For understanding purposes :

M0-Reserve money as on Feb 2024 is 45 trillion while value of M3 is approximately 246 trillion .

Image: RBI Website

Money Supply vs Monetary Base :

• MB is the total value of the currency in circulation and reserve balances, whereas the money supply refers to the quantity of currency with public  and checkable or demand deposits.
• Reserve balances are not included in the money supply calculation, showing that the money supply concept is more about the money available for immediate use. 

MONEY SUPPLY: M1, M2, M3, M4, Narrow Money vs Broad Money

 

                               MONEY SUPPLY:

 

Monetarism (also referred to as “monetarist theory”):

• It is a fundamental macroeconomic theory that focuses on the importance of the money supply as a main driver for economic growth. 
• According to the theory, monetary policy is a much more effective tool than the fiscal policy for stimulating the economy or slowing down the rate of inflation. 

MONEY SUPPLY: 

• The money supply is the total amount of money—cash, coins, and balances in bank accounts—in circulation among the public at a particular point of time. 
• The money supply determines the health status of an economy.
• Any change in the money supply directly affects and determines production, employment, and price levels in the economy.

Different Measures of Money Supply:

• Money supply is classified into various measures on the basis of its functions.
• To adequately capture the variety of assets, Post 1998,  the RBI publishes figures for four alternative measures of money supply, viz. M0, M1, M2 and M3 etc
• Different class of Money has different impact upon the Economy so effective predictions can be made about the likely effects of changes in the different components of money supply. 
• For example, if M1 is increasing firstly it can be reasonably expected that people are planning to make a large number of transactions. On the other hand, if  M3 is increasing , it can be validly concluded that people are planning to save more and accordingly consume less.

01.

M1 = CU + DD +other deposits with RBI, 

where, 

CU = Currency (notes plus coins) held by the public and

DD = Net demand deposits held by commercial banks.

The word ‘net’ implies: Only deposits of the public held by the banks are to be included in money supply. 

Other’ deposits with RBI comprise mainly: 

(i) deposits of quasi-government and other financial institutions including primary dealers, 

(ii) deposits of foreign Central banks and Governments, 

(iii) accounts of international agencies such as the International Monetary Fund, etc.

(IV)Deposits of the Reserve Bank of India Employees' Provident, Gratuity, Super-annotation and Guarantee Funds. All these accounts are maintained with RBI.

M1 excludes:  

1. India’s deposits with IMF, World bank, Foreign Government etc. 2. Interbank deposits.

*******************The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of money supply.

02. 

M2 = M1 + Savings deposits with Post Office savings banks

• 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. 
• However, saving deposits with post offices are more liquid than time deposits with the banks.

03. 

M3 (Money aggregate) = M1 + Net Time deposits with commercial banks (Fixed deposits, Recurring deposits).

NOTE: M3= M1+time and NOT M3=M2+time.

• M3 captures the complete balance sheet of the banking sector and it is the broader form of money.
• M3 is the most commonly used measure of money supply in an Economy. 
• It is also known as aggregate monetary resources. 

04.

M4 = M3 + Total deposits with Post Office savings organisations *(excluding National Savings Certificates)  *meaning those Post Office “time deposits” and “recurring deposits” also but excludes national savings certificate etc.

• M4 is least Liquid Money.
• It is the broadest money in the economy comprising of almost total money components in the economy.

NARROW MONEY :

• M1 and M2 are known as narrow money . 
• These are the most liquid 

BROAD MONEY:

• M3 and M4 are known as broad money. 
• These are the least liquid money.

In terms of Liquidity ,

•  M1 is most liquid and easiest for transactions whereas M4 is least liquid of all. 
• M2 and M4 that include post office savings banks deposits are not very widely used. 
• The reserve money and M3 aggregates are presented both for the components (liabilities) and sources (assets).

CLASSIFICATION OF MONEY,Full-Bodied Money,Representative Full-bodied Money,Credit money,Optional Money

 

MONEY :

Money is an economic liquid asset used to buy goods and services .It  functions as a generally recognized medium of exchange for transactional purposes in an economy. Currency is the basis of economy in the sense that its movement in the economy is the barometer of the health of economy.

CLASSIFICATION OF MONEY :

Money can be classified on various parameters like :

• Liquidity of different money forms EG M0.,M1,M2,M3....
• Backing of money by different reserves in the form of metal or foreign currency and its relationship between the value of money as a commodity and the value of money as money.

Based upon its money as a commodity and the value of money as money, It is classified as Full-bodied Money, Representative Full-bodied Money and Credit Money.

Full-Bodied Money: 

• Full-bodied money refers to any unit of money, whose intrinsic value and face value are equal. 
• For example, During the colonial period, 1 rupee coin was made of silver metal and its monetary value was equal to its commodity value.

The value of silver constituting this coin during Colonial era was 2 Annas .

Representative Full-bodied Money: 

It refers to money which is usually made of paper but 100% backed by metallic reserve of gold or silver.

The value of representative full-bodied money (face value of currency) is much higher than its value as a commodity (paper). 

Credit money:    

• It refers to the money whose intrinsic value (as a commodity) is much lower than its face value, i.e. Money Value (2000 Rs) > Commodity Value (value of paper). 
• In case of credit money, the currency note is not 100 % backed by any metallic reserve or any foreign currency.
• In the modern economies, countries are having currencies in the form of credit money .

                              

For example, face value of Rs 2000 note is Rs 2000, but we would get a much lower value if we sell the note as a piece of paper. Examples are Token coins ,currency notes ,Credit cards, bank deposits.

Optional Money  : 

• Money which is ordinarily accepted by the people for final payments, but has no legal sanction behind it.
• This type of money does not have status of legal tender as it is not have guarantee of central bank.
• No one can be forced to accept them but they are generally accepted because people have confidence in the credit of these types of paper.
• Credit instruments like cheques, bank drafts, bills of exchange, promissory notes etc. are optional money. 

 

If you see the cheque, you will realize that this cheque has the owner's signature unlike the Currency note which has promissory note form the central bank.

FIAT MONEY, LEGAL TENDER, FIAT MONEY vs LEGAL TENDER

 

Fiat Money:

• Fiat money is currency which has been declared to be a legal tender by the government. 
• Fiat currency does  not have any intrinsic value nor it is backed by any physical commodity.
• In the modern Economies, fiat currency is the prevalent mode of currencies which is dominantly in the form of paper. 
• Every currency note bears on its face a promise from the Governor of RBI that "I promise to Pay the bearer the sum of rupees ............ ". 
• This promise entitles the piece of paper a Fiat currency.

• The same is also true of coins. 
• Currency notes and coins are therefore called fiat money.
• The value of fiat currency is derived from the relationship between supply and demand rather than the value of the material that the money is made of. 
• The value of fiat currency is also affected by the inflation in the economy.

Legal tender:

• It is the payment method that is recognised by the law of the land, as valid for payment of debt. 
• The RBI Act of 1934, which gives the central bank the sole right to issue bank notes, states that “Every bank note shall be legal tender at any place in India in payment for the amount expressed therein”.
• They are also called legal tenders as they cannot be refused by any citizen of the country for settlement of any kind of transaction.
• Cheques ,instruments like commercial bills and virtual currency, however, can be refused by anyone as a mode of payment so these  can’t be used as legal tender money.
• When the government withdraws legal tender status to a currency denomination, it cannot be used for settling transactions. 
• Ex. Old currencies after demonetization in India.

Legal tender can either be limited or unlimited in character.

Unlimited Legal tender:

• Currency that can be used for settlement of any amount of debt. 
• In India, all currency notes are unlimited legal tender.

Limited Legal Tender:

In India, coins function as limited legal tender. Coins in India can be used for settlement of dues with certain limitation as mentioned below :

• a coin of any denomination not lower than one rupee, for any sum not exceeding one thousand rupees;
• a half-rupee coin, for any sum not exceeding ten rupees;
• any other coin, for any sum not exceeding one rupee:

LEGAL TENDER VS FIAT MONEY :

• Legal tender refers to a specific form of payment that is recognized by law of the land while fiat money refers to a type of currency that is backed by the government's fiat. 
• In other words, legal tender is a legal requirement for debt settlement, while fiat money is a type of currency that the government has issued.

BUSINESS CYCLE: EXPANSION, SLOWDOWN, CONTRACTION, RECESSION, DEPRESSION, RECOVERY

 

TRADE /BUSINESS CYCLE: 

The study of ups and downs in the Economy is said to be trade cycle of an Economy.

Expansion: 

• Expansion is the phase of the business cycle where real GDP grows accompanied by a rise in employment, growth and investments.
• PEAK in the Economy is that point of time in the Economy when GDP growth rate is at its highest point.

SLOWDOWN: 

• The phase of the business cycle characterized by decrease in growth rate.
•  The Size of GDP increases as the GDP growth rate still remains positive.
• GDP growth rate in : 2017-18-----------------7%,2018-19-----------------6% and 2019-20--------------5% is slowdown as there is slowdown in the growth rate.

CONTRACTION: 

• GDP growth rate is negative in one quarter resulting in decrease in the size of GDP. 
• Ex: Q1=+1%, Q2=-1%, Q3=+3%, Q4=.5%

RECESSION: 

• It is significant decline in economic activities reflected through reduction in GDP growth or negative growth rate, increase in unemployment rate , decrease in demand ,fall in profits  etc,
•  Technically the slowdown is typically for two quarters. 
• Ex.Q1=+1%, Q2=-1%, Q3=-3%,Q4=.5%

DEPRESSION: 

• Depressions is an advanced form of recession lasting longer than three years, resulting in a drop in annual GDP of at least 10%.
• It is characterized as a dramatic downturn in economic activity in conjunction with a sharp fall in growth, employment, and production. 
• The world has experienced depressions in 1930 and 2008.

TROUGH: 

Trough is negative peak of a business cycle where activity is bottoming, before a rise.

RECOVERY:

•  An economic recovery follows after the recession and leads into a new expansionary business cycle phase. 
• It is sustained period of improving business activity characterized by a rise in (GDP), incomes, and employment rates.

MICROECONOMICS vs MACROECONOMICS

 

MICROECONOMICS AND MACROECONOMICS:

As the subject matter of economics, Economics  has been studied under two broad branches:

●        Microeconomics and

●        Macroeconomics.

MICROECONOMICS:

• In microeconomics, we study the behavior of individual economic agents in the markets .
• Microeconomics can be about a sector, a particular region, group of people only rather wholistic purview of Economy.
• Micro-Economics is about how prices and quantities of goods and services are determined through the interaction of individuals in these markets.

• Example. Odd and Even formula for vehicles in Delhi can be an example of microeconomics as it affected auto sector in the NCR region only.

MACROECONOMICS:

• Macroeconomics studies the aggregate economy’s behaviour  in a wholistic manner at the National level .
• The parameter of measurement are Inflation, National income, Growth Rate and GDP.
• Both microeconomics and macroeconomics are dependent and upon each other.

• For example, Slow down in a particular sector is microeconomy but slowdown of GDP growth rate is macroeconomics .

Economy : Understanding and its evolution, Economics vs Economy, Sectors of Economy

 

The Evolution of "Economy":

• The word economy is a Greek word which means "household management." 
• Economics as an area of study was touched on by philosophers in ancient Greece, notably Aristotle, but the modern study of economics began in 18th century Europe and the  Scottish philosopher Adam Smith, who in 1776 wrote the famous economic treatise The Wealth of Nations, was thought of in his own time as a moral philosopher. 
• He and his contemporaries, believed that economies evolved from pre-historic bartering systems to money and eventually credit-based economies.

UNDERSTANDING THE ECONOMY----

Production, exchange and consumption of goods and services are the basic economic activities. There are three basic questions in an economy ie

• What is produced and in what quantities
• How are these goods produced 
• For whom are these goods produced

In the course of these basic economic activities, every society has to face scarcity of resources and it is the scarcity of resources that gives rise to the problem of choice. 

Eg India have 2.4 % of land area in world while it has 18 % of world population. 

ECONOMICS VS ECONOMY :

• Economics is about the optimum decisions about the choices to use its scarce resources in the given economic system to meet the needs of the population.
• Economics aims to comprehend and explain how choices are made in the face of scarce  resources by evaluating the behaviour of different agents in the economy.I
• It digs into the concepts, theories, and frameworks that support production, distribution, and consumption decision-making processes.

                                                                        while 

• Economy represents the large set of inter-related production and consumption activities and  real-world implementation of economic principles and systems. 
• The economy encompasses  everyone from individuals to entities such as corporations and governments.

SECTORS OF ECONOMY:

For better understanding of the functioning of an  economy, an economy can be classified in various sectors. Basically it can be classified as primary ,secondary and tertiary sectors. Now a days tertiary sector can further be classified as Quaternary sector and quinary sector.

PRIMARY SECTOR—

• As the primary means “the basis ”,so this sector is the basis of all other sectors.
• All the subsequent  activities /sectors are dependent upon this sector. 
• This sector includes all the activities  having a direct connection to the environment or in which goods are produced by exploiting natural resources . 
• Since most of the natural products we get are from agriculture, dairy, fishing, forestry, this sector is also called agriculture and related sector along with Mining (extraction of buried material below the surface) and quarrying (Anything extracted from above the surface of earth) which includes oil extraction, coal mining etc. 
• People involved in the primary activities of an economy are also termed as red collar workers due to their association with activities of outdoor nature.

SECONDARY SECTOR--

• The secondary sector is subsequent to the primary sector.
•  It covers all the activities in which natural products are changed into other forms through ways of manufacturing processes. 
• Such processes are  associated with industrial activity. 
• People involved in the secondary sectors of the economy are termed as blue collar workers of the economy.

TERTIARY SECTOR—

• Activities of this sector don’t produce a good at their own. 
• Rather these activities  help in the development  of the primary and secondary sectors. 
• This sector produces intangible goods and are referred to as services.

QUATERNARY SECTOR--- 

Tertiary sector can further be classified into The quaternary and Quinary  sector of the economy .

It refers to describe a knowledge based part of the economy - which typically includes services such as information technology, information-generation and -sharing, media ,research and as well as knowledge-based services like consultation, education, financial planning etc.

QUINARY SECTOR: 

• Part of economy that is involved in decision making eg all the top executives involved in decision making like bureaucrats .  
• Professional under this category often referred as 'gold collar' professionals.

Financial vs Real Economy : 

Economy can also be classified as financial and Real sector .

Financial sector comprises of those aspects of the economy that deals purely with the transaction of money and other financial assets .

                                                                            while 

Real sector encompasses all non-financial enterprises related to production, purchase of goods and services .

Sunrise Industry:

• Sunrise industry is a term used for a sector that is just in its infancy but shows promise of a rapid boom. 
• The industry is typically characterized by high growth rates, high degree of innovation and generally has plenty of public awareness about the sector and investors get attracted to its long-term growth prospects.
• Examples
  
  : Information Technology, Telecom Sector, Healthcare, Infrastructure Sector, Retail Sector and Food Processing Industries.