Monetary-and-credit-policy / Monetary and Credit Policy / Monetary Aggregates..

Monetary Aggregates..

  • Monetary aggregate: A formal accounting method for money, including cash or money market funds.
  • Money supply: Measured using monetary aggregates in a country.
  • Monetary base: Comprises the total supply of money in circulation and the central bank’s reserved portion of commercial bank reserves.
  • Federal Reserve: Utilizes money aggregates as a statistical measure to assess the impact of open-market activities on the economy.

Pointers

 Money aggregates: Broad categories for quantifying an economy's money supply.

  • M0: The monetary base consisting of physical paper and coin money in circulation and central bank reserves.
  • M1: Includes M0 along with traveler’s checks and demand deposits.
  • M2: Encompasses M1, money market shares, and savings deposits.
  • Working Group on Monetary Aggregate: Established under the Chairmanship of Dr. Reddy to analyze the scientific aspects of financial studies.
  • Four monetary aggregates: Proposed by the Working Group based on financial sector liquidity and ranking:
    • M0 (monetary base)
    • M1 (narrow money)
    • M2
    • M3 (broad money).

Reserve Money (M0)

  • Reserve Money: Also known as "High Powered Money" or "Base Money".
  • Total liability of the RBI.
  • Category of cash supply encompassing physical cash (coins and notes), demand deposits, and other liquid assets held by the central bank.
  • M0 formula: Includes currency in circulation, bankers’ deposits with the RBI, and 'other' deposits with the RBI.
  • Currency in circulation: Comprises notes and coins in circulation.
  • Bankers’ deposit with the RBI: Refers to bank's current account deposit with RBI.
  • Other deposits: Encompasses balances in the accounts of foreign central banks, government, and international agencies like the IMF.

Narrow Money (M1)

  • Narrow money aggregates: Focus on the most liquid assets primarily used for spending, such as money and checkable deposits.
  • Components of M1: Consist of currency with the public, demand deposits with banking organizations, and 'other' deposits with the RBI.
  • Demand deposits with the Banking System: Comprise current deposits and the demand liabilities portion of savings deposits.
  • M2: An extension of narrow money, includes savings deposits from post office savings accounts, in addition to the components of M1.
  • Components of M2: Incorporates time liabilities of savings deposits with the Banking System, certificates of deposit issued by banks, and term deposits with a legally binding maturity of up to and including 1 year with the Banking System (excluding CDs).

Broad Money (M3)

  • Broad money: Represents the aggregate of various components including currency with the public, current deposits, savings deposits, certificates of deposits, term deposits, borrowings from non-depository financial institutions by the banking system, and other deposits with RBI.
  • M3: Focuses on the balance sheet of the banking sector.
  • Components of M3: Includes M2, term deposits with a maturity exceeding one year with the Banking System, and call/term borrowings from non-depository financial institutions by the Banking System.

Liquidity and Ranking in Monetary

Name

Type

Liquidity

M0

Narrow Money

Highly Liquid

M1

Narrow Money

Less than M1

M2

Broad Money

Less than M2

M3

Broad Money

Lowest Liquidity

Impact of Monetary Aggregates

  • Monetary aggregates analysis: Offers valuable insights into a country’s financial stability and general health.
  • Example: Rapid growth in monetary aggregates may trigger concerns regarding high inflation rates.
  • Impact of excess money: Prices are likely to increase if there's an excess of money in circulation relative to the quantity of products.
  • Response to high inflation: Central banks may need to raise interest rates or curtail money supply expansion to address high inflationary pressures.

Effects of Monetary Aggregates

  • Monetary aggregates data: Utilized for analyzing a country’s economic health and financial stability.
  • Central banks: Rely on these data to formulate monetary policy over decades.
  • Economists' observations: Highlight a discrepancy between money supply fluctuations and indicators like unemployment, GDP, and inflation.
  • Federal Reserve's role: Its monetary policy is influenced by the central bank's policy and decisions.

Conclusion

  • Monetary aggregates: Play a crucial role in understanding a country’s economy and shaping central banking policy.
  • Observations over decades: Have revealed a weakening connection between money supply changes and key indicators such as inflation, Gross Domestic Product (GDP), and unemployment.