1.5.1. Measures of Money Supply

There are several measures for the money supply, such as M1, M2, M3 and M4.

M1 = Currency with public (coins, currency notes etc.) + net demand deposits held by the public with commercial banks

It includes all those financial assets which are generally accepted as means of payment. M1 is also called as narrow money because we have defined money supply here in a narrow definition of money which emphasizes the medium of exchange function and therefore includes only those assets which are highly liquid. The word ‘net’ implies that only deposits of the public held by the banks are to be included in money supply. The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of money supply. The demand deposits on the other hand are the money deposited by the people in banks and other deposits with the RBI. People issue cheques against these deposits in the banks.

M2 = M1 + Post office saving deposits

Post office savings deposits are far less liquid than commercial bank savings. Savings deposits with post office can be withdrawn on demand, but have the following restrictions:

♤ Chequable portion of these deposits is very small.

♤ There are restrictions on number of withdrawals in any week.

♤ There is a maximum limit on the amount of any single withdrawal (unless an advance notice is given to the post office).

Consequently, post office savings deposits cannot serve as a medium of exchange and are less liquid than the savings deposits with the commercial bank. Both M1 and M2 are known as narrow money.

M3 = M1 + Net time deposits of public with the banks

Some economists believe that time deposits should be included in the money supply as they

are an important form of store of value as in the case of fixed or timed deposits the depositors can borrow from the banks against them. Also, in some cases the depositors are allowed to withdraw their deposits after foregoing some interest and paying a penalty. It is also known as broad money as it included wider definition of money. The basic difference between M1 and M3 is the treatment of timed deposits with the banks. Narrow money excludes the timed deposits of the public with the banking system on the ground that they are incoming earning assets and not liquid in the real sense.

M3 is the most commonly used measure of money supply. It is also known as aggregate monetary resources

M4 = M3 + Total Post office deposits (includes fixed deposits with the post offices but excludes National Savings Certificates)

M3 and M4 are both known as broad money.

Of all the components stated above, currency component is highly liquid followed by demand deposits (easily converted to money on demand). Saving deposits with post-office are next in the line of liquidity. Likewise, the degree of liquidity is less in case of time deposits because they can be converted into cash without loss of money only at the time of maturity. These gradations are in decreasing order of liquidity. M1 is most liquid and easiest for transactions whereas M4 is least liquid of all.