According to recent Reserve Bank of India (RBI) data, the uncertainty caused by the Covid-19 pandemic has led to a surge in money supply.
Key Points
- RBI Data:
- Since the end of March, 2020 currency held by the public increased by 8.2%.
- M3 money supply (refer explanation below) increased by 6.7% in the first five months of 2020 compared with the same period last year. This is the highest growth in seven years.
- Currency in circulation, which measures money with the public and in banks, has also surged.
- However, the savings and current account deposits decreased by 8%. Gross capital formation also fell by 7% in the March, 2020 quarter.
- Reason:
- The recent increase reflects higher cash withdrawals by depositors to meet needs during the lockdown period and also to safeguard themselves against salary cuts or job losses.
- Impact:
- A rise in money supply usually is seen as a leading indicator of growth in consumption and business investments, but due to Covid-19 pandemic, the rise this time is unlikely to bolster either.
- People have curtailed their discretionary spending as they’re not sure of their permanent income.
- Lenders too are unwilling to take risks as slowing discretionary spending slows demand for manufactured and industrial goods.
- Money Supply:
- The total stock of money in circulation among the public at a particular point of time is called money supply.
- It needs to be noted that total stock of money is different from total supply of money.
- Supply of money is only that part of total stock of money which is held by the public at a particular point of time.
- The circulating money involves the currency, printed notes, money in the deposit accounts and in the form of other liquid assets.
- RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4.
- M1 = CU + DD
- M2 = M1 + Savings deposits with Post Office savings banks
- M3 = M1 + Net time deposits of commercial banks
- M4 = M3 + Total deposits with Post Office savings organisations (excluding National Savings Certificates)
- CU is currency (notes plus coins) held by the public and DD is net demand deposits held by commercial banks.
- 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.
- M1 and M2 are known as narrow money. M3 and M4 are known as broad money.
- These gradations are in decreasing order of liquidity.
- M1 is most liquid and easiest for transactions whereas M4 is least liquid of all.
- M3 is the most commonly used measure of money supply. It is also known as aggregate monetary resources.
Key Terms
- Gross capital formation refers to the ‘aggregate of gross additions to fixed assets (that is fixed capital formation) plus change in stocks during the counting period.’
- Fixed asset refers to the construction, machinery and equipment.
- Currency in circulation includes notes in circulation, rupee coins and small coins.
- Currency with the public is arrived at after deducting cash with banks from total currency in circulation.
Source: TH
FAQs
An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending. Business firms respond to increased sales by ordering more raw materials and increasing production.
What results in an increase in the money supply? ›
Central banks can increase money supply by implementing expansionary monetary policies including: Lowering the reserve requirement ratios, which allows commercial banks to lend more money out. Decreasing the discount rate, which makes it cheaper for commercial banks to borrow funds from the central bank.
What will an increase in the money supply likely cause in the short run ______? ›
Expert-Verified Answer
In the short run, an increase in the money supply causes interest rates to decrease, and aggregate demand to shift right. Option C is the correct answer.
What is the result of an increase in the money supply on Quizlet? ›
When the money supply increases, the interest rate falls and investment and consumer spending increases, which leads to an increase in GDP.
Why is increase in money supply bad? ›
When the Fed increases the money supply faster than the economy is growing, inflation occurs. In this situation, the increase in money circulating in an economy is higher than the increase in goods produced.
Does increase in money supply increase demand for money? ›
The reduction in interest rates required to restore equilibrium to the market for money after an increase in the money supply is achieved in the bond market. The increase in bond prices lowers interest rates, which will increase the quantity of money people demand.
What is one result of a high money supply? ›
Effect of Money Supply on the Economy
An increase in the supply of money typically lowers interest rates, which in turn, generates more investment and puts more money in the hands of consumers, thereby stimulating spending.
What would be the likely goal of an increase in money supply? ›
By increasing or decreasing the money supply, the Fed aims to maintain stable prices and moderate interest rates, as well as to promote maximum employment.
Does an increase in the money supply lower interest rates? ›
Money supply and interest rates have an inverse relationship. A larger money supply lowers market interest rates, making it less expensive for consumers to borrow. Conversely, smaller money supplies tend to raise market interest rates, making it pricier for consumers to take out a loan.
What happens if the money supply grows too rapidly? ›
If the money supply grows too big relative to the size of an economy, the unit value of the currency diminishes; in other words, its purchasing power falls and prices rise.
Final answer: A rise in the money supply that's not matched with an increase in production of goods/services leads to inflation, driving prices upward. In other words, as money becomes less powerful, prices rise.
What happens when the supply of money increases faster than the demand for it? ›
To summarize, the money supply is important because if the money supply grows at a faster rate than the economy's ability to produce goods and services, then inflation will result. Also, a money supply that does not grow fast enough can lead to decreases in production, leading to increases in unemployment.
What happens to is curve when money supply increases? ›
Monetary policy has no effect on the IS curve. Expansionary monetary policy shifts the LM curve down (figure 2). The money supply increases, and the interest rate falls. The economy moves down along the IS curve: the fall in the interest rate raises investment demand, which has a multiplier effect on consumption.
Why do increases in money supply decrease interest rates? ›
You can see that there is an inverse relationship - when the Central Bank increases Money Supply (Ms), the MS/P line (Real Money Supply) shifts to the right along the L function (liquidity as a function of volume and interest rate), thereby decreasing the interest rate.
What happens when there is an excess supply of money? ›
The interest rate falls when there is excess supply of money. The interest rate rises when there is an excess demand for money. The mechanism by which changes in the supply and demand for money affect aggregate demand is called the transmission mechanism.
How does increase in money supply affect exchange rate? ›
This theory outlines a significant aspect of this relationship - an increase in money supply can lead to depreciation of the exchange rate, and vice versa. For instance, if the European Central Bank releases more Euros into the market, there are more Euros available for trading.
