According to monetary economists the single most important factor that determines money supply is (H). It is worth noting that Reserve Bank of India and Government are producers of the high-powered money and the commercial banks do not have any role in producing this high-powered money (H). Thus. Content Guidelines 2. This occurs when the Central Bank itself purchases government securities when the government resorts to borrowing. 16.3 where exchange rate of rupee for US dollars (Rs. (iii) Demand deposits of IMF and World Bank. Section I examines which of the existing approaches to defining money is correct. 60,000 crore were kept apart in special deposits with RBI and were not meant to be used by the Government. Content Guidelines 2. Deposits with the banks are broadly divided into two types: demand deposits and time deposits. Answer: C Question Status: Previous Edition Thus, the relationship between money supply and the high-powered money is determined by the money multiplier. It is generally thought that time deposits serve as store of value and represent savings of the people and are not liquid as they cannot be withdrawn through drawing cheque on them. Further, they can be withdrawn at any time by forgoing some interest earned on them. Secondly, the imports of goods will increase aggregate supply of goods in the economy which will tend to lower prices. To do so more rupee currency is printed by RBI to pay for US dollars purchased by it. In India, the money supply, in a narrow sense, includes both currency in the hands of the public and deposits at banks that households can use on demand for transactions, such as chequing accounts. Let us summaries the four concepts of money supply as used by Reserve Bank of India in the following tabular form: In order to explain the determinants of money supply in an economy we shall use M, concept of money supply which is the most fundamental concept of money supply. When the supply of high-powered money (i.e., reserve money) H increases; 2. The amount of high-powered money is fixed by RBI by its past actions. If in equation (2) above aggregate expenditure (C + I + G) exceeds national output (Y), current account balance or NX will be negative, that is, imports will be greater than exports. Sterilization refers to the action by the Central Bank of a country to offset or cancel the impact of its foreign exchange market intervention on the money supply through open market operations. If there is a net adverse balance of payments, rupees would flow into the Reserve Bank which pays out foreign exchange. First, the money supply refers to the total sum of money available to the public in the economy at a point of time. As a result of Central Bank intervention to meet the current account deficit and to maintain the exchange rate money supply in the economy decreases. 10 was not withdrawn by the borrower. Privacy Policy3. However, it is more popularly called ‘Money-multiplier Theory of Money Supply’ because it explains the determination of money supply as a certain multiple of the high- powered money. Thus more high-power money (i.e., rupee currency) would come into circulation in the Indian economy. (ii) Demand deposits of foreign Central Banks and Foreign Governments. Thus, Where, M = Total money supply with the public. That is, when there is a decrease in currency reserves with the banks, there will be multiple contraction in demand deposits with the banks. Share Your Word File The money supply, therefore, depends on three exogenous variables: Changes in these variables cause the money supply to change: (i) Money supply is directly proportional to the monetary base (B), an increase in B. increases the money supply by the same percentage. Price as a Determinant of Supply Price is perhaps the most obvious determinant of supply. In the open economy there is free flow of goods and services through trade with foreign countries. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. RBI has also resorted to sterilization of increase in money supply by selling government securities to the banks and thereby getting back the money issued by it. ‘The multiplier model of the money supply, originally developed by Brunner (1961) and Brunner and Meltzer (1964) has become the standard model to explain how the policy actions of the Central Bank influence the money stock’ [ 1 ] . In this way money supply in the economy increases which offsets the decrease in money supply brought about by the Central Bank when it sells foreign exchange to prevent the depreciation of the domestic currency. In economic analysis it is generally presumed that money supply is determined by the policy of Central Bank of a country and the Government. 1000 assuming that no leakage of cash to the public occurs during the process of deposit expansion by the banks. 90 and so the process will continue as the borrowers use these deposits for payment through cheques to others who deposit them in another bank B. Change in the high-powered money is decided and controlled by Reserve Bank of India, the money multiplier determines the extent to which decision by RBI regarding the change in high-powered money will bring about change in the total money supply in the economy. May not be the relationship a proportional one, but excessive increase in money supply leads to inflation. This is done to neutralize the monetary impact of large accumulation of net foreign exchange assets with RBI caused by capital inflows on a large scale. Determination of the Multiplier - Free download as PDF File (.pdf), Text File (.txt) or read online for free. Whenever money supply rose abnormally in the past in an economy, inflationary situation developed there. With this agreement, Market Stabilisation Scheme (MSS) has been started. The working group on monetary reforms under the chairmanship of late Prof. Sukhamoy Chakravarty recommended its use for monetary planning of the economy and setting target of the growth of money supply in terms of M3. 2. We explain the sterilization operations by RBI later. However, this excludes contributions made by the public to the national saving certificates. It is the latter course of action that was adopted by Reserve Bank of India before 1995 when government’s fiscal deficit was high and a good part of it was monetised by it. We have seen above, Money Market Equilibrium in an Economy (With Problems). It may be noted that demand deposits are fiduciary money proper. This is the narrow measure of money supply and is composed of the following items: DD = Demand deposits with the public in the commercial and cooperative banks. Bank deposits are created when people deposit currency with them. Fiduciary money is one which functions as money on the basis of trust of the persons who make payment rather than on the basis of the authority of Government. Share Your PDF File It provides only purely accounting or ex-post analysis of variations in money supply and the factors or sources causing these variations. On the other hand, in 2011 the RBI faced the opposite problem when after August 2011, there was net large capital outflow from India due to uncertainty caused by European debt crisis and economic slowdown in the US. (iii) Cash reserves on hand with all banks. Lower the rr, greater will be the loans given by the bank and thus greater will be the credit creation. In this way some rupee currency had been withdrawn from the economy. The ratio r in the deposit multiplier is the required cash reserve ratio fixed by Reserve Bank of India. It may be noted that other deposits of Reserve Bank of India constitute a very small proportion (less than one per cent). Therefore, the monetary base is also called high-powered money. Now, if in a year there is deficit in current account, that is, NX is negative, it means our demand for foreign exchange, say, the US dollars, for imports of goods and services will exceed the supply of foreign exchange. In August 2004 foreign exchange reserves has risen to US $ 119 billion. have to be kept and against this any amount of currency can be issued depending on the monetary requirements of the economy. Second, it is assumed the exchange rate is not allowed to change as a result of in balance between demand and supply of foreign exchange due to current account deficit. Thus, management of money supply is essential in the interest of steady economic growth. In the two years (2006-08) due to large net capital inflows in the Indian economy there was quite a large appreciation of the Indian rupee against US dollar that produced undesirable effects. The deficit in current account balance requires the Central Bank to sell foreign exchange from its reserves to prevent the depreciation of domestic currency (that is, to maintain the exchange rate constant). National income of the open economy is written as: where NX stands for net exports or trade balance. Let us first explain sterilization operation by the Central Bank in case of deficit in current account of the balance of payments. DETERMINATION OF MONEY SUPPLY IN NIGERIA Money supply is one of the important macroeconomic variables.The control of money supply is an essential That is, one rupee of high- powered money kept as bank reserves gives rise to much more amount of demand deposits. • There are some differences in the definitions of money supply from country to country. The sale of foreign exchange in foreign exchange market by the Central Bank causes money supply in the economy to decrease that has deflationary effect on the economy. For example, households need money to buy groceries and firms need money to pay for materials and labor. From April 1977, the Reserve Bank of India has adopted four concepts of money supply in its analysis of the quantum of and variations in money supply. Note that in measuring demand deposits with the public in the banks (i.e., DD), inter-bank deposits, that is, deposits held by a bank in other banks, are excluded from this measure. This is for two reasons. R = Cash Reserves of currency with the banks. • Broad money supply, M2, consists of M1 Plus other deposits (savings deposits, time deposits, etc.). 48 per US dollar, EH is the increase in capital inflows. The monetary base is the quantity of government-produced money. 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