The number of rupee notes and coins in circulation. As a result, our foreign exchange reserves have substantially gone up, which have resulted in the issue and expansion of rupee currency in circulation. The deficit in current account balance requires the Central Bank to sell foreign exchange from its reserves to prevent the depreciation of domestic currency (that is, to maintain the exchange rate constant). This means that the money supply is determined not only by the monetary policy of the central bank, but also by the behaviour of households (which hold money) and of banks (in which money is held). Welcome to! Money supply data is collected, recorded, and published periodically, typically by the country's government or central bank. In addition to the three items of M1, the concept of money supply M2 includes savings deposits with the post office savings banks. We have seen above, Money Market Equilibrium in an Economy (With Problems). Changes in the foreign exchange assets held by the Reserve Bank can also bring about a change in the money supply. The Determinants of the Money Supply The money multiplier, reserve and currency ratios, and borrowed reserves 2. • Broad money supply, M2, consists of M1 Plus other deposits (savings deposits, time deposits, etc.). However, if the Central Bank wants to maintain the exchange rate at OR, then current account deficit equal to LK has to be met. First, different components of money supply have been distinguished on the basis of the different functions that money performs. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. Now suppose there is surplus in overall balance of payment as capital inflows exceed the deficit in current account. determination in India: balance sheet or structural approach and money multiplier approach; the former focused on individual items in the balance sheet of the consolidated monetary sector in order to explain changes in money supply and Economists refer to the phenomenon that quantity supplied increases as price increases as the law of supply. How the high-powered money (H) is related to the total money supply is graphically depicted in Fig. This is for two reasons. Therefore, it is called as (H) theory of money supply or money multiplier theory. Thus deposit multiplier of 10 shows that for every Rs. (d) $1800. This is because banking system has greatly developed there and also people have developed banking habits. Thus, changes in high-powered money are the result of decisions of Reserve Bank of India or the Government which owns and controls it. Privacy Policy3. H, that is, the amount of high-powered money, which is also called reserve money, 2. r, that is, cash reserve ratio of banks (i. e., ratio of currency reserves to deposits of the banks). (ii) Money supply is inversely related with rr and cr. The figure shows the average money holdings of a family that earns a three thousand dollar paycheck per month. By buying US dollars equal to EH, RBI will cause the demand curve for US dollars to shift to the right to the new position D’D’ and the new equilibrium is established at point H which corresponds to Rs. The money supply is the most liquid measure of money supply as the money included in it can be easily used as a medium of exchange, that is, as a means of making payments for transactions. When the cash or currency reserves-deposit ratio of the banks (r) falls. The transactions of an open economy also affect the growth of money supply in it. The Central Bank (RBI) will print new notes to pay for the purchase of foreign exchange. For example, in recent years there has been a large-scale inflow of foreign exchange through investment made by foreign companies and NRI deposits in India. However, if the economy is in the grip of a severe depression, the risk of causing inflation through monetisation of budget deficit and consequent growth in money supply is not much there. The large capital inflows can occur due to heavy foreign direct investment (FDI) and portfolio investment by foreign institutional investors (FII) as it happened in some years in India, especially in 2006-07, 2007-08 and 2010-11. This is because in M3 measure the problem of dividing. Currency with the public (C) in the above measure of money supply consists of the following: (ii) Circulation of rupee coins as well as small coins. 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. The Government includes Central and the State Government. (d) Government’s currency liabilities to the public. The other important component of money supply are demand deposits of the public with the banks. In August 2004 foreign exchange reserves has risen to US $ 119 billion. 45 per US dollar. 60,000 crore were kept apart in special deposits with RBI and were not meant to be used by the Government. (c) $1200. Monetary base B: (B = C + R) → It is directly controlled by the bank. Fiduciary money is one which functions as money on the basis of trust of the persons who make payment rather than on the basis of the authority of Government. This depreciation of rupee will make our imports costlier which will tend to raise inflation if not matched by fall in international commodity prices. In this case there will be no impact of deficit in current account balance of payments on money supply in the economy. It may be noted here that since 1995, a good part of budget deficit is financed through open market operations by RBI by selling Government securities to the banks. It is also known as high powered money. – Explained. It will be further seen that whereas currency held by the public (Cp) uses the same amount of high-powered money, that is, there is one-to-one relationship between currency held by the public and the money supply. This implies that our exports will be greater than imports. However, banks may like to keep with themselves some excess reserves, the amount of which depends on the extent of liquidity (i.e. More so, Nnanna, (2002) and Ojo, (2001) in the process of identifying the assets and liabilities of the financial sector, define money supply (M2) which is the expanded of narrow measure of money (M1) to include time and saving deposits at the money banks (DMBs) which is also term Quasi-money (QM) which are not directly useable as a means of payment but can in practice be converted into generally … The second link between budget deficit and expansion in money supply is direct. To avoid this adverse effect, the Central Bank buys government securities (i. e., bonds) through open market operations. depositors) • CB can change the level of money supply (Ms) via – Changing MB (e.g. This will lead to the increase in money supply in the economy. Second, it is assumed the exchange rate is not allowed to change as a result of in balance between demand and supply of foreign exchange due to current account deficit. Growth of money supply is an important factor not only for acceleration of the process of economic development but also for the achievement of price stability in the economy. This happens when budget deficit is financed through borrowing from the market. Before publishing your Articles on this site, please read the following pages: 1. Deposit multiplier measures how much increase in demand deposits (or money supply) occurs as a result of a given increase in cash or currency, reserves with the banks depending on the required cash reserve ratio (r) if there are no cash drainage from the banking system. In the open economy there is free flow of goods and services through trade with foreign countries. Thus, a decrease in rr raises the money multiplier and the money supply. The Central Bank is said to monetize budget deficit when it purchases government securities as it prints new notes for the purpose and gives it to the government for meeting public expenditure. Theory of determination of money supply explains how a given supply of high-powered money (which is also called monetary base or reserve money) leads to multiple expansion in money supply through the working of money multiplier. First, this will reduce rupee currency in circulation which will cause reduction in money supply in the economy. Hence various measures of money supply are prepared to meet the needs of monetary analysis and policy formulation. 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. DETERMINATION OF MONEY SUPPLY IN NIGERIA ABSTRACT Money supply is one of the important macroeconomic variables. That is, one rupee of high- powered money kept as bank reserves gives rise to much more amount of demand deposits. Another measure of money supply is M 3 which includes both M1 and time deposits held by the public in the banks. (iii) Cash reserves on hand with all banks. This drainage of currency to the people in the real world reduces the magnitude of expansion of demand deposit and therefore the size of money multiplier. Thus. The Determination Of The Money Supply Traditionally, it has been shown controversially that money supply is determined using the base multiplier approach. 16.1. The change in the net foreign assets may be caused by balance of payment situation. Secondly, the imports of goods will increase aggregate supply of goods in the economy which will tend to lower prices. The bank A will lend out Rs. The supply of money is pretty easy to describe graphically. Money Supply • As they are quickly and easily used for transactions, they are called transactions money. National income of the open economy is written as: where NX stands for net exports or trade balance. This unpredictable variation in money multiplier in the short run affecting money supply in the economy prevents the Central Bank of a country from controlling exactly and precisely the money supply in the economy. These 4 definitions are given in descending order of liquidity. 48 per US dollar, it will have to buy US dollars equal to EH from the market. 80 as new deposits instead of Rs. It is determined by the business policies banks and the laws regulating banks. This is done to neutralize the monetary impact of large accumulation of net foreign exchange assets with RBI caused by capital inflows on a large scale. We have seen above how a small increase in reserves of currency with the banks leads to a multiple expansion in demand deposits by the banks through the process of deposit multiplier and thus causes growth of money supply in the economy. 48 per US dollar, EH is the increase in capital inflows. Whereas Government can borrow more or less compulsorily from Reserve Bank of India, the private sector cannot do so from the commercial banks. Answer: C Question Status: Previous Edition Some economists therefore call it ‘The H Theory of Money Supply’. If instead currency reserves held by the banks increase, this will not change the money supply immediately but will set in motion a process of multiple creation of demand deposits of the public in the banks. 90 and therefore create demand deposits of Rs. When as a result of increase in cash reserves, banks start increasing demand deposits, the people may also like to have some more currency with them as money balances.

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