ICAI Notes- Unit 2: The Concept of Money Supply | Business Economics for CA Foundation PDF Download

 Page 1


1.22  
 
BUSINESS ECONOMICS 
 
 8.22 
LEARNING OUTCOMES 
UNIT – 2: CONCEPT OF MONEY 
SUPPLY 
 
 
 
 
After studying this Unit, you will be able to – 
? Define money supply and describe its different components  
? List out the need for and rationale of measuring money supply 
? Elucidate the different sources of money supply 
? Illustrate the various measures of money supply 
? Distinguish between money multiplier and credit multiplier, and  
? Describe the different determinants of money supply 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement of 
Money Supply 
Determinants 
of Money 
Supply 
The concept 
of Money 
Multiplier 
The Sources of 
Money Supply 
The concept of 
Money Supply 
Money Market 
UNIT OVERVIEW 
 
© The Institute of Chartered Accountants of India
Page 2


1.22  
 
BUSINESS ECONOMICS 
 
 8.22 
LEARNING OUTCOMES 
UNIT – 2: CONCEPT OF MONEY 
SUPPLY 
 
 
 
 
After studying this Unit, you will be able to – 
? Define money supply and describe its different components  
? List out the need for and rationale of measuring money supply 
? Elucidate the different sources of money supply 
? Illustrate the various measures of money supply 
? Distinguish between money multiplier and credit multiplier, and  
? Describe the different determinants of money supply 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement of 
Money Supply 
Determinants 
of Money 
Supply 
The concept 
of Money 
Multiplier 
The Sources of 
Money Supply 
The concept of 
Money Supply 
Money Market 
UNIT OVERVIEW 
 
© The Institute of Chartered Accountants of India
 1.23 
 
 
 
8.23 
MONEY MARKET 
2.1 INTRODUCTION 
In the previous unit, we discussed the theories related to the demand for money. Money as a 
means of payment and thus a lubricant that facilitates exchange. Irrespective of the form of 
money, in any economy, money performs three primary functions – a medium of exchange, a 
unit of account, and a store of value. Money as a medium of exchange may be used for any 
transactions wherein goods or services are purchased or sold. Money as a unit of account can 
be used to value goods or services and express it in monetary terms. Money can also be stored 
or conserved for future purposes. 
In the real world, however, money provides monetary services along with tangible 
remuneration. It is for this reason that money must have a relationship with the activities that 
economic entities pursue. Money can, therefore, be defined for policy purposes as a set of 
liquid financial assets, the variation in the stock of which could impact aggregate economic 
activity. 
Economic stability requires that the supply of money at any time should to be maintained at 
an optimum level.  A pre-requisite for achieving this is to accurately estimate the stock of 
money supply on a regular basis and appropriately regulate it in accordance with the 
monetary requirements of the country. In this unit, we shall look into various aspects related 
to the supply of money.    
Money Supply on December 30
th,
 2022  
Item Outstanding as on   
 2022 2022 
 March 31 December 30 
1 2 3 
M3 (In Crores) 2,04,93,729 2,18,59.358 
Components (i+ii+iii+iv)   
i) Currency with the Public 30,35,689 31,22,019 
ii) Demand deposits with Banks 22,12,992 23,41,912 
iii) Time Deposits with Banks 1,51,86,605 1,63,32,494 
iv) ‘Other’ Deposits with Reserve Bank 58,444 62,932 
Source (i+ii+iii+iv – v)   
i) Net Bank Credit to Government Sector (a+b) 64,77,629 65,65,472 
(a) Reserve Bank 14,50,596 11,70,253 
© The Institute of Chartered Accountants of India
Page 3


1.22  
 
BUSINESS ECONOMICS 
 
 8.22 
LEARNING OUTCOMES 
UNIT – 2: CONCEPT OF MONEY 
SUPPLY 
 
 
 
 
After studying this Unit, you will be able to – 
? Define money supply and describe its different components  
? List out the need for and rationale of measuring money supply 
? Elucidate the different sources of money supply 
? Illustrate the various measures of money supply 
? Distinguish between money multiplier and credit multiplier, and  
? Describe the different determinants of money supply 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement of 
Money Supply 
Determinants 
of Money 
Supply 
The concept 
of Money 
Multiplier 
The Sources of 
Money Supply 
The concept of 
Money Supply 
Money Market 
UNIT OVERVIEW 
 
© The Institute of Chartered Accountants of India
 1.23 
 
 
 
8.23 
MONEY MARKET 
2.1 INTRODUCTION 
In the previous unit, we discussed the theories related to the demand for money. Money as a 
means of payment and thus a lubricant that facilitates exchange. Irrespective of the form of 
money, in any economy, money performs three primary functions – a medium of exchange, a 
unit of account, and a store of value. Money as a medium of exchange may be used for any 
transactions wherein goods or services are purchased or sold. Money as a unit of account can 
be used to value goods or services and express it in monetary terms. Money can also be stored 
or conserved for future purposes. 
In the real world, however, money provides monetary services along with tangible 
remuneration. It is for this reason that money must have a relationship with the activities that 
economic entities pursue. Money can, therefore, be defined for policy purposes as a set of 
liquid financial assets, the variation in the stock of which could impact aggregate economic 
activity. 
Economic stability requires that the supply of money at any time should to be maintained at 
an optimum level.  A pre-requisite for achieving this is to accurately estimate the stock of 
money supply on a regular basis and appropriately regulate it in accordance with the 
monetary requirements of the country. In this unit, we shall look into various aspects related 
to the supply of money.    
Money Supply on December 30
th,
 2022  
Item Outstanding as on   
 2022 2022 
 March 31 December 30 
1 2 3 
M3 (In Crores) 2,04,93,729 2,18,59.358 
Components (i+ii+iii+iv)   
i) Currency with the Public 30,35,689 31,22,019 
ii) Demand deposits with Banks 22,12,992 23,41,912 
iii) Time Deposits with Banks 1,51,86,605 1,63,32,494 
iv) ‘Other’ Deposits with Reserve Bank 58,444 62,932 
Source (i+ii+iii+iv – v)   
i) Net Bank Credit to Government Sector (a+b) 64,77,629 65,65,472 
(a) Reserve Bank 14,50,596 11,70,253 
© The Institute of Chartered Accountants of India
1.24  
 
BUSINESS ECONOMICS 
 
 8.24 
(b) Other Banks 50,27,033 53,95,219 
ii) Bank Credit to Commercial Sector (a+b) 1,26,16,520 1,40,44,417 
(a) Reserve Bank 16,571 19,852 
(b) Other Banks 1,25,99,950 1,40,24,565 
iii) Net Foreign Exchange Assets of Banking Sector 48,54,063 47,46,428 
iv) Government Currency Liabilities to the Public 28,013 29,384 
v) Banking Sector’s Net Non-Monetary Liabilities 34,82,496 35,26,343 
 of which: Net Non-Monetary Liabilities of R.B.I. 13,08,500 14,94,789 
Source : RBI Press Release: 2022-2023/1540 
M3 is broad money. M3 = M1 + Time deposits with the banking system. M2 = M1 + Savings 
deposits of post office savings banks. M1 = Currency with public + Demand deposits with the 
Banking system (savings account, current account). 
Broad money (M3) includes currency, deposits with an agreed maturity of up to two years, 
deposits redeemable at notice of up to three months and repurchase agreements, money 
market fund shares/units, and debt securities up to two years 
The term ‘public’ is defined to include all eco nomic units (households, firms, and institutions) 
except the producers of money (i.e. the government and the banking system).  
The government, in this context, includes the central government and all state governments 
and local bodies; and the banking system means the Reserve Bank of India and all the banks 
that accept demand deposits (i.e. deposits from which money can be withdrawn by cheque 
mainly CASA deposits). The word ‘public’ is inclusive of all local authorities, non -banking 
financial institutions, and non-departmental public-sector undertakings, foreign central banks 
and governments and the International Monetary Fund which holds a part of Indian money in 
India in the form of deposits with the RBI. In other words, while discussing the definition of 
‘supply of money’ and the standard measures of money , interbank deposits and money held 
by the government and the banking system are not included.  
2.2 RATIONALE OF MEASURING MONEY SUPPLY 
The empirical analysis of the money supply is important for two reasons: 
1. It facilitates analysis of monetary developments in order to provide a deeper 
understanding of the causes of money growth.  
© The Institute of Chartered Accountants of India
Page 4


1.22  
 
BUSINESS ECONOMICS 
 
 8.22 
LEARNING OUTCOMES 
UNIT – 2: CONCEPT OF MONEY 
SUPPLY 
 
 
 
 
After studying this Unit, you will be able to – 
? Define money supply and describe its different components  
? List out the need for and rationale of measuring money supply 
? Elucidate the different sources of money supply 
? Illustrate the various measures of money supply 
? Distinguish between money multiplier and credit multiplier, and  
? Describe the different determinants of money supply 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement of 
Money Supply 
Determinants 
of Money 
Supply 
The concept 
of Money 
Multiplier 
The Sources of 
Money Supply 
The concept of 
Money Supply 
Money Market 
UNIT OVERVIEW 
 
© The Institute of Chartered Accountants of India
 1.23 
 
 
 
8.23 
MONEY MARKET 
2.1 INTRODUCTION 
In the previous unit, we discussed the theories related to the demand for money. Money as a 
means of payment and thus a lubricant that facilitates exchange. Irrespective of the form of 
money, in any economy, money performs three primary functions – a medium of exchange, a 
unit of account, and a store of value. Money as a medium of exchange may be used for any 
transactions wherein goods or services are purchased or sold. Money as a unit of account can 
be used to value goods or services and express it in monetary terms. Money can also be stored 
or conserved for future purposes. 
In the real world, however, money provides monetary services along with tangible 
remuneration. It is for this reason that money must have a relationship with the activities that 
economic entities pursue. Money can, therefore, be defined for policy purposes as a set of 
liquid financial assets, the variation in the stock of which could impact aggregate economic 
activity. 
Economic stability requires that the supply of money at any time should to be maintained at 
an optimum level.  A pre-requisite for achieving this is to accurately estimate the stock of 
money supply on a regular basis and appropriately regulate it in accordance with the 
monetary requirements of the country. In this unit, we shall look into various aspects related 
to the supply of money.    
Money Supply on December 30
th,
 2022  
Item Outstanding as on   
 2022 2022 
 March 31 December 30 
1 2 3 
M3 (In Crores) 2,04,93,729 2,18,59.358 
Components (i+ii+iii+iv)   
i) Currency with the Public 30,35,689 31,22,019 
ii) Demand deposits with Banks 22,12,992 23,41,912 
iii) Time Deposits with Banks 1,51,86,605 1,63,32,494 
iv) ‘Other’ Deposits with Reserve Bank 58,444 62,932 
Source (i+ii+iii+iv – v)   
i) Net Bank Credit to Government Sector (a+b) 64,77,629 65,65,472 
(a) Reserve Bank 14,50,596 11,70,253 
© The Institute of Chartered Accountants of India
1.24  
 
BUSINESS ECONOMICS 
 
 8.24 
(b) Other Banks 50,27,033 53,95,219 
ii) Bank Credit to Commercial Sector (a+b) 1,26,16,520 1,40,44,417 
(a) Reserve Bank 16,571 19,852 
(b) Other Banks 1,25,99,950 1,40,24,565 
iii) Net Foreign Exchange Assets of Banking Sector 48,54,063 47,46,428 
iv) Government Currency Liabilities to the Public 28,013 29,384 
v) Banking Sector’s Net Non-Monetary Liabilities 34,82,496 35,26,343 
 of which: Net Non-Monetary Liabilities of R.B.I. 13,08,500 14,94,789 
Source : RBI Press Release: 2022-2023/1540 
M3 is broad money. M3 = M1 + Time deposits with the banking system. M2 = M1 + Savings 
deposits of post office savings banks. M1 = Currency with public + Demand deposits with the 
Banking system (savings account, current account). 
Broad money (M3) includes currency, deposits with an agreed maturity of up to two years, 
deposits redeemable at notice of up to three months and repurchase agreements, money 
market fund shares/units, and debt securities up to two years 
The term ‘public’ is defined to include all eco nomic units (households, firms, and institutions) 
except the producers of money (i.e. the government and the banking system).  
The government, in this context, includes the central government and all state governments 
and local bodies; and the banking system means the Reserve Bank of India and all the banks 
that accept demand deposits (i.e. deposits from which money can be withdrawn by cheque 
mainly CASA deposits). The word ‘public’ is inclusive of all local authorities, non -banking 
financial institutions, and non-departmental public-sector undertakings, foreign central banks 
and governments and the International Monetary Fund which holds a part of Indian money in 
India in the form of deposits with the RBI. In other words, while discussing the definition of 
‘supply of money’ and the standard measures of money , interbank deposits and money held 
by the government and the banking system are not included.  
2.2 RATIONALE OF MEASURING MONEY SUPPLY 
The empirical analysis of the money supply is important for two reasons: 
1. It facilitates analysis of monetary developments in order to provide a deeper 
understanding of the causes of money growth.  
© The Institute of Chartered Accountants of India
 1.25 
 
 
 
8.25 
MONEY MARKET 
2. It is essential from a monetary policy perspective as it provides a framework to evaluate 
whether the stock of money in the economy is consistent with the standards for price 
stability and to understand the nature of deviations from this standard. The central 
banks all over the world adopt monetary policy to stabilise price level and GDP growth 
by directly controlling the supply of money. This is achieved mainly by managing the 
quantity of monetary base. The success of monetary policy depends to a large extent 
on the controllability of the monetary base and the money supply.  
2.3 THE SOURCES OF MONEY SUPPLY 
The supply of money in the economy depends on:  
(a) the decision of the central bank based on the authority conferred on it, and 
(b) the supply responses of the commercial banking system of the country to the changes  
in policy variables initiated by the central bank to influence the total money supply in 
the economy. 
Money either has intrinsic value or represents title to commodities that have intrinsic value or 
title to other debt instruments. In modern economies, the currency is a form of money that is 
issued exclusively by the sovereign (or a central bank as its representative) and is legal tender. 
Paper currency is such a representative money, and it is essentially a debt instrument.  
It is a liability of the issuing central bank (and sovereign) and an asset of the holding public. 
The central banks of all countries are empowered to issue currency and, therefore, the central 
bank is the primary source of money supply in all countries. In effect, high powered money 
issued by monetary authorities is the source of all other forms of money. The currency issued 
by the central bank is ‘fiat money’ and is backed by supporting reserves and its value is 
guaranteed by the government.  
The currency issued by the central bank is, in fact, a liability of the central bank and the 
government.  Therefore, in principle, it must be backed by an equal value of assets mainly 
consisting of gold and foreign exchange reserves. In practice, however, most countries have 
adopted a ‘minimum reserve system’ wherein the central bank is empowered to issue currency 
to any extent by keeping only a certain minimum reserve of gold and foreign securities. 
The second major source of money supply is the banking system of the country. The total 
supply of money in the economy is also determined by the extent of credit created by the 
commercial banks in the country. Banks create money supply in the process of borrowing and 
lending transactions with the public. Money so created by the commercial banks is called 
'credit money’.  The high-powered money and the credit money broadly constitute the most 
© The Institute of Chartered Accountants of India
Page 5


1.22  
 
BUSINESS ECONOMICS 
 
 8.22 
LEARNING OUTCOMES 
UNIT – 2: CONCEPT OF MONEY 
SUPPLY 
 
 
 
 
After studying this Unit, you will be able to – 
? Define money supply and describe its different components  
? List out the need for and rationale of measuring money supply 
? Elucidate the different sources of money supply 
? Illustrate the various measures of money supply 
? Distinguish between money multiplier and credit multiplier, and  
? Describe the different determinants of money supply 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement of 
Money Supply 
Determinants 
of Money 
Supply 
The concept 
of Money 
Multiplier 
The Sources of 
Money Supply 
The concept of 
Money Supply 
Money Market 
UNIT OVERVIEW 
 
© The Institute of Chartered Accountants of India
 1.23 
 
 
 
8.23 
MONEY MARKET 
2.1 INTRODUCTION 
In the previous unit, we discussed the theories related to the demand for money. Money as a 
means of payment and thus a lubricant that facilitates exchange. Irrespective of the form of 
money, in any economy, money performs three primary functions – a medium of exchange, a 
unit of account, and a store of value. Money as a medium of exchange may be used for any 
transactions wherein goods or services are purchased or sold. Money as a unit of account can 
be used to value goods or services and express it in monetary terms. Money can also be stored 
or conserved for future purposes. 
In the real world, however, money provides monetary services along with tangible 
remuneration. It is for this reason that money must have a relationship with the activities that 
economic entities pursue. Money can, therefore, be defined for policy purposes as a set of 
liquid financial assets, the variation in the stock of which could impact aggregate economic 
activity. 
Economic stability requires that the supply of money at any time should to be maintained at 
an optimum level.  A pre-requisite for achieving this is to accurately estimate the stock of 
money supply on a regular basis and appropriately regulate it in accordance with the 
monetary requirements of the country. In this unit, we shall look into various aspects related 
to the supply of money.    
Money Supply on December 30
th,
 2022  
Item Outstanding as on   
 2022 2022 
 March 31 December 30 
1 2 3 
M3 (In Crores) 2,04,93,729 2,18,59.358 
Components (i+ii+iii+iv)   
i) Currency with the Public 30,35,689 31,22,019 
ii) Demand deposits with Banks 22,12,992 23,41,912 
iii) Time Deposits with Banks 1,51,86,605 1,63,32,494 
iv) ‘Other’ Deposits with Reserve Bank 58,444 62,932 
Source (i+ii+iii+iv – v)   
i) Net Bank Credit to Government Sector (a+b) 64,77,629 65,65,472 
(a) Reserve Bank 14,50,596 11,70,253 
© The Institute of Chartered Accountants of India
1.24  
 
BUSINESS ECONOMICS 
 
 8.24 
(b) Other Banks 50,27,033 53,95,219 
ii) Bank Credit to Commercial Sector (a+b) 1,26,16,520 1,40,44,417 
(a) Reserve Bank 16,571 19,852 
(b) Other Banks 1,25,99,950 1,40,24,565 
iii) Net Foreign Exchange Assets of Banking Sector 48,54,063 47,46,428 
iv) Government Currency Liabilities to the Public 28,013 29,384 
v) Banking Sector’s Net Non-Monetary Liabilities 34,82,496 35,26,343 
 of which: Net Non-Monetary Liabilities of R.B.I. 13,08,500 14,94,789 
Source : RBI Press Release: 2022-2023/1540 
M3 is broad money. M3 = M1 + Time deposits with the banking system. M2 = M1 + Savings 
deposits of post office savings banks. M1 = Currency with public + Demand deposits with the 
Banking system (savings account, current account). 
Broad money (M3) includes currency, deposits with an agreed maturity of up to two years, 
deposits redeemable at notice of up to three months and repurchase agreements, money 
market fund shares/units, and debt securities up to two years 
The term ‘public’ is defined to include all eco nomic units (households, firms, and institutions) 
except the producers of money (i.e. the government and the banking system).  
The government, in this context, includes the central government and all state governments 
and local bodies; and the banking system means the Reserve Bank of India and all the banks 
that accept demand deposits (i.e. deposits from which money can be withdrawn by cheque 
mainly CASA deposits). The word ‘public’ is inclusive of all local authorities, non -banking 
financial institutions, and non-departmental public-sector undertakings, foreign central banks 
and governments and the International Monetary Fund which holds a part of Indian money in 
India in the form of deposits with the RBI. In other words, while discussing the definition of 
‘supply of money’ and the standard measures of money , interbank deposits and money held 
by the government and the banking system are not included.  
2.2 RATIONALE OF MEASURING MONEY SUPPLY 
The empirical analysis of the money supply is important for two reasons: 
1. It facilitates analysis of monetary developments in order to provide a deeper 
understanding of the causes of money growth.  
© The Institute of Chartered Accountants of India
 1.25 
 
 
 
8.25 
MONEY MARKET 
2. It is essential from a monetary policy perspective as it provides a framework to evaluate 
whether the stock of money in the economy is consistent with the standards for price 
stability and to understand the nature of deviations from this standard. The central 
banks all over the world adopt monetary policy to stabilise price level and GDP growth 
by directly controlling the supply of money. This is achieved mainly by managing the 
quantity of monetary base. The success of monetary policy depends to a large extent 
on the controllability of the monetary base and the money supply.  
2.3 THE SOURCES OF MONEY SUPPLY 
The supply of money in the economy depends on:  
(a) the decision of the central bank based on the authority conferred on it, and 
(b) the supply responses of the commercial banking system of the country to the changes  
in policy variables initiated by the central bank to influence the total money supply in 
the economy. 
Money either has intrinsic value or represents title to commodities that have intrinsic value or 
title to other debt instruments. In modern economies, the currency is a form of money that is 
issued exclusively by the sovereign (or a central bank as its representative) and is legal tender. 
Paper currency is such a representative money, and it is essentially a debt instrument.  
It is a liability of the issuing central bank (and sovereign) and an asset of the holding public. 
The central banks of all countries are empowered to issue currency and, therefore, the central 
bank is the primary source of money supply in all countries. In effect, high powered money 
issued by monetary authorities is the source of all other forms of money. The currency issued 
by the central bank is ‘fiat money’ and is backed by supporting reserves and its value is 
guaranteed by the government.  
The currency issued by the central bank is, in fact, a liability of the central bank and the 
government.  Therefore, in principle, it must be backed by an equal value of assets mainly 
consisting of gold and foreign exchange reserves. In practice, however, most countries have 
adopted a ‘minimum reserve system’ wherein the central bank is empowered to issue currency 
to any extent by keeping only a certain minimum reserve of gold and foreign securities. 
The second major source of money supply is the banking system of the country. The total 
supply of money in the economy is also determined by the extent of credit created by the 
commercial banks in the country. Banks create money supply in the process of borrowing and 
lending transactions with the public. Money so created by the commercial banks is called 
'credit money’.  The high-powered money and the credit money broadly constitute the most 
© The Institute of Chartered Accountants of India
1.26  
 
BUSINESS ECONOMICS 
 
 8.26 
common measure of money supply, or the total money stock of a country. (For a brief note 
on the process of creation of credit money, refer to Box 1, end of this chapter).  
With the developments in the economy and the evolution of the payments system, the form 
and functions of money has changed over time, and it will continue to influence the future 
course of currency. The concept of money has experienced evolution from Commodity to 
Metallic Currency to Paper Currency to Digital Currency. The changing features of money are 
defining new financial landscape of the economy. Further, with the advent of cutting-edge 
technologies, digitalization of money is the next milestone in the monetary history. 
Advancement in technology has made it possible for the development of new form of money 
viz. Central Bank Digital Currencies (CBDCs). 
Recent innovations in technology-based payments solutions have led central banks around 
the globe to explore the potential benefits and risks of issuing a CBDC so as to maintain the 
continuum with the current trend in innovations. RBI has also been exploring the pros and 
cons of introduction of CBDCs for some time and is currently engaged in working towards a 
phased implementation strategy, going step by step through various stages of pilots followed 
by the final launch, and simultaneously examining use cases for the issuance of its own CBDC 
(Digital Rupee (e?)), with minimal or no disruption to the financial system. Currently, we are 
at the forefront of a watershed movement in the evolution of currency that will decisively 
change the very nature of money and its functions. 
Reserve Bank broadly defines CBDC as the legal tender issued by a central bank in a digital 
form. It is akin to sovereign paper currency but takes a different form, exchangeable at par 
with the existing currency and shall be accepted as a medium of payment, legal tender and a 
safe store of value. CBDCs would appear as liability on a central bank’s balance sheet.  
The Crypto currencies face significant legislative uncertainties and are not legally recognized 
in India as currency.  Hence, these are not categorized as money.  In a massive development 
for crypto traders in India, the Reserve Bank of India (RBI) has said that banks or other financial 
entities cannot cite RBI’s 2018 order that barred them from dealing with virtual 
cryptocurrencies. 
2.4 MEASUREMENT OF MONEY SUPPLY  
There is virtually a profusion of different types of money, especially credit money, and this 
makes measurement of money supply a difficult task. Different countries follow different 
practices in measuring money supply.  The measures of money supply vary from country to 
country, from time to time and from purpose to purpose. Reference to such different measures 
is beyond the scope of this unit. Just as other countries do; a range of monetary and liquidity 
© The Institute of Chartered Accountants of India