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Which of the following is/are the components of high-powered money?
1. Currency held by public
2. Currency held by commercial banks
3. Foreign Exchange reserves held by RBI
Select the correct answer using the code given below.
- a)1 and 2 only
- b)2 and 3 only
- c)1 only
- d)1, 2 and 3
Correct answer is option 'A'. Can you explain this answer?
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Verified Answer
Which of the following is/are the components of high-powered money?1. ...
- Determination of the money supply is currently expressed in terms of the monetary base or high-powered money.
- High-powered money is the sum of commercial bank reserves and currency (notes and coins) held by the Public. High-powered money is the base for the expansion of bank deposits and the creation of a money supply. Hence only options 1 and 2 are correct.
- The supply of money varies directly with changes in the monetary base and inversely with the currency and reserve ratios.
- The use of high-powered money consists of the demand of commercial banks for the legal limit or required reserves with the central bank and excess reserves, and the demand of the public for currency. Thus, High power money
- H = C + RR + ER
- Where, C = represent currency, RR = Required reserves, ER = The Excess reserves
- A commercial bank’s reserves depend upon its deposits. But a bank usually holds reserves in excess of its required reserves. In fact, banks do not advance loans up to the legal limits and remain precisely under that. Hence the need arises for maintaining excess reserves by them.
- Thus, the money supply is determined by the required reserve ratio and the excess reserve ratio of commercial banks.
- The formal relation between the money supply and high powered money can be stated as in the form of equations:
- The money supply(M) consists of deposits of commercial banks (D) and currency (C) held by the public.
- Thus the supply of money (M) = D + C
- High-powered money (H) (or monetary base) consists of currency held by the public(C), required reserves (RR) and excess reserves of commercial banks.
- Thus, High powered money (H) = C + RR + ER
Most Upvoted Answer
Which of the following is/are the components of high-powered money?1. ...
Components of High-Powered Money:
1. Currency held by public:
It refers to the total amount of currency notes and coins that are in circulation among the general public and are not held by the commercial banks. The currency held by the public is a part of the high-powered money as it is the liability of the central bank.
2. Currency held by commercial banks:
The commercial banks hold a certain amount of currency with them which is known as cash reserve ratio (CRR). This is the percentage of deposits that the banks have to maintain with the central bank. This reserve maintained by the commercial banks is a part of the high-powered money.
3. Foreign Exchange reserves held by RBI:
Foreign exchange reserves refer to the foreign currency deposits and bonds held by the central bank. These reserves are held to maintain the stability of the domestic currency and also to meet any external financial obligations. The foreign exchange reserves held by the RBI are also a part of the high-powered money.
Therefore, the correct answer is option 'A', i.e. 1 and 2 only. Foreign exchange reserves held by RBI are not a component of high-powered money.
1. Currency held by public:
It refers to the total amount of currency notes and coins that are in circulation among the general public and are not held by the commercial banks. The currency held by the public is a part of the high-powered money as it is the liability of the central bank.
2. Currency held by commercial banks:
The commercial banks hold a certain amount of currency with them which is known as cash reserve ratio (CRR). This is the percentage of deposits that the banks have to maintain with the central bank. This reserve maintained by the commercial banks is a part of the high-powered money.
3. Foreign Exchange reserves held by RBI:
Foreign exchange reserves refer to the foreign currency deposits and bonds held by the central bank. These reserves are held to maintain the stability of the domestic currency and also to meet any external financial obligations. The foreign exchange reserves held by the RBI are also a part of the high-powered money.
Therefore, the correct answer is option 'A', i.e. 1 and 2 only. Foreign exchange reserves held by RBI are not a component of high-powered money.
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