MONEY

SUPPLY

Submitted By:
M.RajeshReddy
GSIB Regd. No.: 1226115124
M.Satynarayana
GSIB Regd. No.: 1226115125
G.N.S Prasadarao
GSIB Regd. No.: 12261151109

Submitted To:
B. Padma Narayan
Assistant Professor-Economics
GITAM School of International Business
Visakhapatnam, Andhra Pradesh, India
(GITAM University)

MONEY

The word money is derived from the Latin word Moneta which was the surname of the
Roman Goddess of Juno in whose temple at Rome, money was coined. The origin of money
is lost in antiquity. Even the primitive man had some sort of money. The type of money in
every age depended on the nature of its livelihood. In a hunting society, the skins of wild
animals were used as money. The pastoral society used livestock, whereas the agricultural
society used grains and foodstuffs as money. The Greeks used coins as money. Stages in the
evolution of money the evolution of money has passed through the following five stages
depending upon the progress of human civilization at different times and places.

1. Commodity money
Various types of commodities have been used as money from the beginning of human
civilization. Stones, spears, skins, bows and arrows, and axes were used as money in the
hunting society. The pastoral society used cattle as money. The agricultural society used
grains as money. The Romans used cattle and salt as money at different times. The
Mongolians used squirrel skins as money. Precious stones, tobacco, tea shells, fishhooks and
many other commodities served as money depending upon time, place and economic
standard of the society.
The use of commodities as money had the following defects. All the commodities were not
uniform in quality, such as cattle, grains, etc. Thus lack of standardization made pricing
difficult.

It is difficult to store and prevent loss of value in the case of perishable

commodities. Supplies of such commodities were uncertain. They lacked in portability and
hence were difficult to transfer from one place to another. There was the problem of
indivisibility in the case of such commodities as cattle.

2. Metallic money
With the spread of civilization and trade relations by land and sea, metallic money took the
place of commodity money. Many nations started using silver, gold, copper, tin, etc. as
money .But metal was an inconvenient thing to accept, weigh, divide and assess in quality
accordingly, metal was made into coins of predetermined weight. This innovation is
attributed to King Midas of Lydia in the eighth century B C. But gold coins were used in
India many centuries earlier than in Lydia. Thus coins came to be accepted as convenient
method of exchange.

As the price of gold began to rise, gold coins were melted in order to earn more by selling
them as metal. This led governments to mix copper or silver in gold coins since their intrinsic
value might be more than their face value. As gold became dearer and scarce, silver coins
were used, first in their pure form and later on mixed with alloy or some other metal. But
metallic money had the following limitations.
(I) It was not possible to change its supply according to the requirements of the nation both
for internal and external use.
(ii) Being heavy, it was not possible to carry large sums of money in the form of coins from
one place to another by merchants.
(iii) It was unsafe and inconvenient to carry precious metals for trade purposes over long
distances.
(iv) Metallic money was very expensive because the use of coins led to their debasement and
their minting and exchange at the mint cost a lot to the government.

3. Paper money
The development of paper money started with goldsmiths who kept strong safes to store their
gold. As goldsmiths were thought to be honest merchants, people started keeping their gold
with them for safe custody. In return, the goldsmiths gave the depositors a receipt promising
to return the gold on demand. These receipts of the goldsmiths were given to the sellers of
commodities by the buyers. Thus receipts of the goldsmith were a substitute for money. Such
paper money was backed by gold and was convertible on demand into gold. This ultimately
led to the development of bank notes. The bank notes are issued by the central bank of the
country. As the demand for gold and silver increased with the rise in their prices, the
convertibility of bank notes into gold and silver was gradually given up during the beginning
and after the First World War in all the countries of the world. Since then the bank money has
ceased to be representative money and is simply fiat money which is inconvertible and is
accepted as money because it is backed by law.

4. Credit money
Another stage in the evolution of money in the modern world is the use of the cheque as
money. The cheque is like a bank note in that it performs the same function. It is a means of
transferring money or obligations from one person to another. But a cheque is different from
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a bank note. A cheque is made for a specific sum, and it expires with a single transaction. A
cheque is not money. It is simply a written order to transfer money. However, large
transactions are made through cheques these days and bank notes are used only for small
transactions.

5. Near money
The final stage in the evolution of money has been the use of bills of exchange, treasury bills,
bonds, debentures, savings certificates, etc. They are known as near money. They are close
substitutes for money and are liquid assets. Thus, in the final stage of its evolution money
became intangible. Its ownership in now transferable simply by book entry Definition of
Money to give a precise definition of money is a difficult task. Various authors have given
different definition of money. According to Crowther, Money can be defined as anything
that is generally acceptable as a means of exchange and that at the same time acts as a
measure and a store of value. Professor D H Robertson defines money as anything which is
widely accepted in payment for goods or in discharge of other kinds of business obligations.
From the above two definitions of money two important things about money can be noted.
Firstly, money has been defined in terms of the functions it performs. That is why some
economists defined money as money is what money does. It implies that money is anything
which performs the functions of money.
Secondly, an essential requirement of any kind of money is that it must be generally
acceptable to every member of the society. Money has a value for A only when he thinks
that B will accept it in exchange for the goods. And money is useful for B only when he is
confident that C will accept it in settlement of debts. But the general acceptability is not the
physical quality possessed by the good. General acceptability is a social phenomenon and is
conferred upon a good when the society by law or convention adopts it as a medium of
exchange. Functions of Money
The major functions of money can be classified into three. They are: The primary functions,
secondary functions and contingent functions.

The primary functions of money are Medium of exchange and Measure of value

1. Medium of exchange
The most important function of money is that it serves as a medium of exchange. In the barter
economy commodities were exchanged for commodities. But it had experienced many
difficulties with regard to the exchange of goods and services. To undertake exchange, barter
economy required double coincidence of wants. Money has removed this problem. Now a
person A can sell his goods to B for money and then he can use that money to buy the goods
he wants from others who have these goods. As long as money is generally acceptable, there
will be no difficulty in the process of exchange. By serving a very convenient medium of
exchange money has made possible the complex division of labour or specialization in the
modern economic organization.

2. Measure of value
Another important function of money is that the money serves as a common measure of value
or a unit of account. Under barter system there was no common measure of value and the
value of different goods were measured and compared with each other. Money has solved this
difficulty and serves as a yardstick for measuring the value of goods and services. As the
value of all goods and services are measured in terms of money, their relative values can be
easily compared.
The secondary functions of money are;

1. Standard of deferred payments

Another important function of money is that it serves as a standard for deferred payments.
Deferred payments are those payments which are to be made in future. If a loan is taken
today, it would be paid back after a period of time. The amount of loan is measured in terms
of money and it is paid back in money. A large amount of credit transactions involving huge
future payments are made daily. Money performs this function of standard of deferred
payments because its value remains more or less stable. When the price changes the value of
money also changes. For instance, when the prices are falling, value of money will rise. As a
result, the creditors will gain in real terms and the debtors will lose. Conversely, when the
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prices are rising (or, value of money is falling) creditors will be the losers. Thus if the money
is to serve as a fair and correct standard of deferred payments, its value must remain stable.
Thus when there is severe inflation or deflation, money ceases to serve as a standard of
deferred payments.

2. Store of value
Money acts as a store of value. Money being the most liquid of all assets is a convenient form
in which to store wealth. Thus money is used to store wealth without causing deterioration or
wastage. In the past gold was popular as a money material. Gold could be kept safely without
deterioration. Of course, there are other assets like houses, factories, bonds, shares, etc., in
which wealth can be stored. But money performs as a different thing to store the value.
Money being the most liquid of all assets has the advantage that an individual or a firm can
buy with it anything at any time. But this is not the case with other assets. Other assets like
buildings, Shares, etc., have to be sold first and converted into money and only then they can
be used To buy other things. Money would perform the store of value function properly if it
remains Stable in value.
In short, money has removed the difficulties of barter system, namely, lack of double
Coincidence of wants, lack of division and lack of measure and store of value and lack of a
Standard of deferred payment. It has facilitated trade and has made possible the complex
division of labour and specialization of the modern economic system.

III. Contingent functions

The important contingent functions of money are;
1. Basis of credit
It is with the development of money market the credit market began to flourish.
2. Distribution of national income
Being a common measure of value, money serves as the best medium to distribute the
national income among the four factors of production.
3. Transfer of value
Money helps to transfer value from one place to another.
4. Medium of compensations
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Accidents and carelessness cause damage to the property and life. Compensation can be paid
to such damages in terms of money
5. Liquidity
Liquidity means the ready purchasing power or convertibility of money in to any commodity.
Money is the most liquid form of all assets.

6. Money guide in production and consumption.

Utility of goods and services can be expressed in terms of money. Similarly, marginal
productivity is measured in terms of prices of goods and factors. Thus money become the
base of measurement and which directs the production and consumption.
7. Guarantor of solvency
Solvency refers to the ability to pay off debt. Persons and firms have to be solvent while
doing the business. The deposits of money serves as the best guarantor of solvency.
Token money: Is a form of money in which the metallic value of which is much less than its
real value (or face value). Rupees and all other coins in India are all token money.
Bank money: Demand deposits of banks are usually called bank money. Bank deposits are
created when somebody deposits money with them. Banks also creates deposits when they
advance loans to the businessmen and traders. These demand deposits are the important
constituent of the money supply in the country. It is important to note that bank deposits are
generally divided into two categories: demand deposits and time deposits. Demand deposits
are those deposits which are payable on demand through cheques and without any serving
prior notice to the banks. On the other hand, time deposits are those deposits which have a
fixed term of maturity and are not withdrawable on demand and also cheques cannot be
drawn on them. Clearly, it is only demand deposits which serve as a medium of exchange, for
they can be transferred from one person to another through drawing a cheque on them as and
when desired by them. However, since time or fixed deposits can be withdrawn by forgoing
some interest and can be used for making payments, they are included in the concept of broad
money, generally called M3.

Inside money is a term that refers to any debt that is used as money. It is a liability to the
issuer. The net amount of inside money in an economy is zero. At the same time, most money
circulating in a modern economy is inside money. Outside money is a term that refers to
money that is not a liability for anyone "inside" the economy. It is held in an economy in net
positive amounts. Examples are gold or assets denominated in foreign currency or otherwise
backed up by foreign debt, like foreign cash, stocks or bonds. Typically, the private economy
is considered as the "inside", so government issued money is also "outside money."

Demand for money

Why people have demand for money to hold is an important issue in macroeconomics. The
level of demand for money not only determines the rate of interest but also the level of prices
and national income of the economy. The demand for money arises from two important
functions of money.

The first is that money acts as a medium of exchange and the second is that it is a store of
value. Thus individuals and businesses wish to hold money partly in cash and partly in the
form of assets. What determines the changes in demand for money is a major issue. There are
two views. The first is the scale view which is related to the impact of the income or wealth
levels upon the demand for money. The demand for money is directly related to the income
level. The higher the income level, the greater will be the demand for money.
The second is the substitution view which is related to relative attractiveness of assets that
can be substituted for money. According to this view, when alternative assets like bonds
become unattractive due to fall in interest rates, people prefer to keep their assets in cash, and
the demand for money increases, and vice versa. The scale and substitution view combined
together have been used to explain the nature of the demand for money which has been split
into the transactions demand, the precautionary demand and the speculative demand.
Classical economists considered money as simply a means of payment or medium of
exchange. In the classical model, people, therefore, demand money in order to make
payments for their Purchases of goods and services. In other words, they want to keep money
for transaction purposes. On the other hand J M Keynes also laid stress on the store of value
function of money. According to him, money is an asset and people want to hold it so as to
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take advantage of changes in the price of this asset, that is, the rate of interest. Therefore
Keynes emphasized another motive for holding money which he called speculative motive.
Under speculative motive, people demand to hold money balances to take advantage from the
future changes in the rate of interest or what means the same thing from the future changes in
bond prices.
An essential point to be noted about peoples demand for money is that what people want is
not nominal money holdings, but real money balances. This means that people are
interested in the purchasing power of their money balances, that is, the value of money
balances In terms of goods and services which they could buy. Thus people would not be
interested in merely nominal money holdings irrespective of the price level that is, the
number of rupee notes and the bank deposits. If with the doubling of price level, nominal
money holdings are also doubled, their real money balances would remain the same. If people
are merely concerned with nominal money holdings irrespective of price level.

The Supply of Money

The supply of money is a stock at a particular point of time, though it conveys the idea of a
flow over time. The supply of money at any moment is the total amount of money in the
economy. There are three alternative views regarding the definitions or measures of money
supply. The most common view is associated with the traditional and Keynesian thinking
which stresses the medium of exchange function of money. According to this view, money
supply is defined as currency with the public and demand deposits with the commercial
banks. Demand deposits are savings and current accounts of depositors in a commercial bank.
They are the liquid form of money because depositors can draw cheques for any amount
lying in their accounts and the bank has to make immediate payment on demand. Demand
deposits with the commercial bank plus currency with the public are together denoted as M1,
the money supply. This is regarded as the narrower definition of the money supply.
The second definition is broader and is associated with the modern quantity theorists headed
by Friedman. Proof Friedman defines the money supply at any moment of time as literally
the number of dollars people are carrying around in their pockets, the number of dollars they
have to their credit at banks or dollars they have to their credit at banks in the form of
demand deposits, and also commercial bank time deposits. Time deposits are fixed deposits
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of customers in a commercial bank. Such deposits earn a fixed rate of interest varying with
the time period for which the amount is deposited. Money can be withdrawn before the
expiry of that period by paying a penal rate of interest to the bank. So time deposits posse
liquidity and are included in the money supply by Friedman. Thus the definition includes M1
plus time deposits of commercial banks in the supply of money. This wider definition is
termed as M2 in America and M3 in Britain and India. It stresses the store of value function
of money.
The third function is the broadest and is associated with Gurley and Shaw. They include in
the money supply, M2 plus deposits of saving banks, building societies, loan associations,
and deposits of other credit and financial institutions.

Measures of Money Supply in India

There are four measures of money supply in India which are denoted by M1, M2, M3, and
M4. This classification was introduced by Reserve Bank of India (RBI) in April, 1977. Prior
to this till March, 1968, the RBI published only one measure of money supply, M or M1
which is defined as currency and demand deposits with the public.
Keynesian views of the narrow measure of money supply. From April, 1968 the RBI also
started publishing another measure of the money supply which is called Aggregate Monetary
Resources (AMR). This included M1 plus time deposits of banks held by the public. This was
a broad measure of money supply which was in line with Friedmans view.
Since April, 1977, the RBI has been publishing data on four measures of the money supply
which are cited below;
M1 The first measure of money supply M1 consists of: Currency with the public which
includes notes and coins of all denominations in circulation excluding cash in hand with
banks Demand deposits with commercial and co-operative banks, excluding inter-bank
deposits; and Other deposits with RBI which include current deposits of foreign central
banks, financial institutions and quasi-financial institutions such as IDBI, IFCI, etc. RBI
characterizes M1 as narrow money.

Data

Money Supply M1 in India increased to 24356.39 INR Billion in November from 23864.20
INR Billion in October of 2015. Money Supply M1 in India averaged 4647.22 INR Billion
from 1972 until 2015, reaching an all-time high of 24356.39 INR Billion in November of
2015 and a record low of 80.15 INR Billion in January of 1972. Money Supply M1 in India is
reported by the Reserve Bank of India.

M2 The second measure of money supply M2 consists of M1 plus post office savings bank
deposits. Since savings bank deposits commercial and co-operative banks are included in the
money supply, it is essential to include post office saving bank deposits. The majority of
people in rural and urban have preference or post office deposits from the safety viewpoint
than bank deposits.

Data
Money Supply M2 in India increased to 24879.90 INR Billion in November
from 24372.67 INR Billion in October of 2015. Money Supply M2 in India
averaged 8265.16 INR Billion from 1991 until 2015, reaching an all time
high of 24879.90 INR Billion in November of 2015 and a record low of
1127.49 INR Billion in November of 1991. Money Supply M2 in India is
reported by the Reserve Bank of India.

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M3 The third measure of money supply in India M3 consists of M1 plus time deposits with
commercial and cooperative banks, excluding interbank time deposits. The RBI calls M3 as
broad money.

Data
Money Supply M3 in India increased to 112528.14 INR Billion in November
from 112200.55 INR Billion in October of 2015. Money Supply M3 in India
averaged 18458.07 INR Billion from 1972 until 2015, reaching an all-time
high of 112528.14 INR Billion in November of 2015 and a record low of
123.52 INR Billion in January of 1972. Money Supply M3 in India is
reported by the Reserve Bank of India.

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Data of Coins& Notes in India

Determinants of Money Supply

In order to explain the determinants of money supply in an economy we shall use the M1
concept of money supply which is the most fundamental concept of money supply. We shall
denote it simply by M rather than M1. As seen above this concept of money supply (M1) is
composed of currency held by the public (Cp) and demand deposits with the banks (D).
Thus;
M1 = Cp + D - (1)
Where M = Total money supply with the public
Cp = currency with the public
D = demand deposits held by the public.
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.
1. High-powered money (H)
The high-powered money consists of the currency (notes and coins) issued by the
government and the RBI. A part of the currency issued is held by the public, which we
designate as Cp and a part is held by the banks as reserves which we designate as R. A part of

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these currency reserves of the bank is held by them in their own cash vaults and a part is
deposited in the Reserve Bank of India in the reserve accounts which banks hold with RBI.
Accordingly, the high-powered money can be obtained as sum of currency held by the public
and the part held by the banks as reserves. Thus,
H = Cp + R (2)
Where H = the amount of high-powered money
Cp = Currency held by the public
R = Cash reserves of currency with the banks.
It is to be noted that RBI and Government are the producers of the high-powered money and
the commercial banks do not have any role in producing this high-powered money (H).
However, the commercial banks are producers of demand deposits which are also used as
money like currency. But for producing demand deposits or credit, banks have to keep with
themselves cash reserves of currency which have been denoted by R in equation (2) above.
Since these cash reserves with the banks serve as a basis for the multiple creation of demand
deposits which constitute an important part of total money supply in the economy. It provides
high POW redness to the currency issued by the Reserve Bank and the Government.
The theory of determination of money supply is based on the supply of and demand for high
powered money. Some economists call it The H Theory of Money Supply. However, it is
more popularly called Money Multiplier Theory of Money Supply because it explains the
determination of money supply as a certain multiple of the high powered money.

Money Multiplier
In monetary economics, a money multiplier is one of various closely related ratios of
commercial bank money to central bank money under a fractional-reserve banking system.
Most often, it measures the maximum amount of commercial bank money that can be created
by a given unit of central bank money. Thus
m=M/H
Rearranging this we have
M = H. m
Thus money supply is determined by the size of money multiplier (m) and the amount of
High powered money (H).
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