money supply in india

Topics: Monetary policy, Fractional-reserve banking, Money supply Pages: 18 (2481 words) Published: December 17, 2013
 Macro Economics Assignment


Money Supply in India

Submitted to
Dr. B.Padma Narayan


Feroz Khan (1226113114) & B. Harish Kumar (1226113118)

The supply of money is a stock at their particular point of time, though it conveys the idea of a flow over time. Money supply is defined as currency with the public and demand deposits with commercial banks. Demand deposits are savings and current accounts of depositors in a commercial bank. They are the liquid form of money because depositors can draw cheques for any amount lying in their accounts and the hank has to make immediate payment on demand. Demand deposits with commercial banks plus currency with the public are together denoted as M1 the money supply. This is regarded as a: narrower, definition of the money supply. The first definition of money supply may be analytically better because M1 is a sure medium of exchange. But M1 is an inferior store of value because it earns no rate of interest, as is earned by time deposits. Further, the central bank can have control over a narrower area if only demand deposits are included in the money supply. Determinants of money supply:

There are two theories of the determination of the money supply. According to the firstview, the money supply is determined exogenously by the central bank. The second view holds that the money supply is determined endogenously by changes in the economic activity which affect people's desire to hold currency relative to deposits, the rate of interest, etc. Thus the determinants of money supply are both exogenous and endogenous which can be described broadly as: the minimum cash reserve ratio, the level of bank reserves, and the desire of the people to hold currency relative to deposits. The last two determinants together are called the monetary base or the high powered money. 1. The Required Reserve Ratio

The required reserve ratio (or the minimum cash reserve ratio or the reserve deposit ratio) is an important determinant of the money supply. An increase in the required reserve ratio reduces the supply of money with commercial banks and a decrease in required reserve ratio increases the money supply. The RRI is the ratio of cash to current and time deposit liabilities which is determined by law. Every commercial bank is required to keep a certain percentage of these liabilities in the form of deposits with the central bank of the country. But notes or cash held by commercial banks in their tills are not included in the minimum required reserve ratio. But the short-term assets along with the cash are regarded as the liquid assets of a commercial bank. In India the statutory liquidity ratio (SLR) has been fixed by law as an additional measure to determine the money supply. The SLR is called 'Secondary reserve ratio in other countries while the required reserve ratio is referred to as the primary ratio. The raising of the SLR has the effect of reducing the money supply with commercial banks for lending purposes, and the lowering of the SLR tends to increase the money supply with banks for advances. 2. The Level of Bank Reserves

The level of bank reserves is another determinant of the money supply. Commercial bank reserves consist of reserves on deposits with the central bank and currency in their tills vaults. It is the central bank of the country that influences the reserves of commercial banks in order to determine the supply of money. The central bank requires all commercial banks to hold reserves equal to a fixed percentage of both time and demand deposits. These are legal minimum or...
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