Money Supply Demand

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The Supply and Demand of Money

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What is Money?

common sense

- Money is the set of assets in an economy thatpeople regularly use to buy goods and servicesfrom other people.

- Money is anything that is generallyacceptable by the people as a means of

payment in the final settlement of alltransactions including debts.


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The Functions of Money

Anything that satisfies the four important function of it,-- a Medium of exchange,

- a Unit of measurement of Value

- a Standard of deferred payment

- a Store of Value

Amedium of exchange is anything that is readily acceptable as paymentfor buying and selling goods and services.

A unit of account is the yardstick people use to post prices and recorddebts.

Differed Payment: Payment in future

Astore of value is an item that people can use to transfer purchasing powerfrom the present to the future.

Money is the most liquid assets . Liquidity is the ease with which an assetcan be converted into the economys medium of exchange.

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The Kinds of Money1. Barter System- Goods were exchanged against goods

2. Commodity Money: any money that is both used as a general purposemedium of exchange and as a tradable commodity in its own right. Ex. Coinsof precious metal.

3.Representative Money: Money that consists of token coins, other physicaltokens such as certificates and even non-physical certif icates that can bereliably exchanged for a fixed qty of commodity such as gold, silver ,oil etc.

4. Credit Money:Any claim against a physical or legal person that can be usedfor the purchase of goods and services.

5. Fiat Money: the value of which is determined by legal means (legal tender)ex. Notes of RBI.

1.Coins- not full bodied money but token money (intrinsic value


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MONEY SUPPLY

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The Supply of Money means the volume ofmoney held by the

public in the country for transaction purpose.

Money is Supplied by

a. Reserve Bank of India,

b. Commercial Banks

c. Central Government of India

Money Supply which is held by the public is generally fixed during

a given year.

Money Stock: Total Volume of money at a point of time,

Ex. Dec 31, 2007, held by the public in the country for transaction

purposes

Money Supply (Ms): Total volume of money during a period of

time, Ex. April 1, 2006- 31 March 2007, held by the public in the

country for transaction purposes

Supply of Money


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Printing of Coins and Currencies Agencies

Involved

RBI

Banks

(chests)

MOF

GovtPresses

Mints

Police Railways

RBI'sPresses

Central Gov. Mints Coins

RBI prints Currencies

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How much to Print & Mint Replacement needs ( old worn and tear one)

Incremental needs ( demand for money)

Reserve Stock Requirement Needs(CRR, SLR, gold reserve, Forex reserve)

Growth rate of GDP

Assess the stock on daily basis

Uses statistical analysis and long-term forecast Printing/minting allocated between the

presses/mints and delivery schedule decided inadvance

Uses some Statistical models


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Mint

Press

Issue Offices

Chandigarh

New DelhiJaipur

Lucknow

KanpurPatna

Guwahati

AhamadabadCalcutta

Hyderabad

Banglore

Trivandrum

Chennai

MumbaiByculla

Bhuaneshwar

Nagpur

Mysore

Nasik

Dewas Salboni

Noida

Mumbai

Hyderabad

Calcutta

Bhopal

India Cross-movement of Currency

Fresh Notes/Coins fromPress/Mint pass on to thebanks/public only through

RBI offices hence cross-movement

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Capacity of Presses & Mints

Total annual capacity of Presses: 18 bn

Can print up to 28 bn with two shifts

Total minting capacity: 4,700 mn

RBIs annual needs:

Notes: about 12,000 mn pieces

Coins: about 5,000 mn pieces


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Flow of Notes & Coins

Presses

RBI Offices

Chest branches

Public

NOTES

4 Mints

4 mint-linked RBI Offices

Chest branches & RBIOffices

Public

COINS

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Network of Currency Chests

RBI is located only in 18 places for currency operations

Distribution of notes and coins throughout the country is donethrough designated bank branches, called chests.

RBI has authorized selected branches of scheduled banksto establish currency chest.

As of June 30, 2006, there were 4428 currency chests and4102 small coins depots.

Chest is a receptacle in a commercial bank to store notesand coins on behalf of the Reserve Bank

Deposit into chest leads to credit of the commercial banksaccount and withdrawal is debit


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Currency Chest More on

Meets currency requirementof public

Withdraws unfit notes

Exchange facility from onedenomination to another

Payment requirement of theGovernment

Exchange of mutilated notes

Avoids frequent movement of

cash

Chest branch operates withminimum cash balance

Currency Chest Mechanism

Net deposit /withdrawal of notes and

coins at the chest is reported on dailybasis to parent Issue Office

Overall deposit or withdrawal leads to

credit or debit of banks account in RBI

Net withdrawal from chests means

expansion of currency and deposits

means contraction

Notes in circulation being the liability of

RBI, it adjusts its asset-liability position

centrally for such expansion or

contraction

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RBIs

Empirical Estimation(Definition) of

Money Supply


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RBI or Empirical Definition of Money:M0 (Reserve Money), M1(narrow money), M2, M3(broad money)

Mo =Currency in circulation + Banker's deposit with RBI+ Other deposits with RBI

Other deposits with RBI= (i) deposits of quasi govt and other financial institutions such as Primary Dealers' balances in the

accounts of foreign centrals banks and govts (iii)accounts of IMF, (iv) provident funds, gratuity and guarantee funds of RBI staff.

18Primary dealeris a formal designation of a firm as a market makerof government securities


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Reserve Money (M0) =1+2+3-4


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Sources of Changes in High Powered Money (H)

1. Net Central Bank Credit to Government (i-ii)i. Claims on Government( loans and advances to Govt +Investment in Govt.Securities)

ii. Govt Deposits with central bank

2. Central Bank Credit to Banks

bank rate, reporate etc.

3. Central Bank Credit to Commercial Sector

Shares/bonds of financial institutions

debentures of cooperative banks

loans to financial institutions

4. Net Foreign Exchange Assets of Central Bank

a. Investment if Foreign assets

b. Gold

5. Government's Currencies Liabilities to the Public

a. Rupee Coins and small coins

6. Net Non-Monetary Liabilities of the Central bank

a. Reserves, b. Paid up reserves, c. other liabilities etc.

High Powered Money(H) =1+2+3+4+5-6

High Powered Money= reserve Money + Govts Currency Liabilities to the Public

H=M0+GCL

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Sources of Changes in Broad Money Supply (M3)

1. Net Bank Credit to Government (a+b)

a. Central bank Net Credit to Govt (i-ii)

i. Claims on Government

ii. Govt Deposits with central bank

b. Other Banks credit to Government

2. Bank Credit to Commercial Sector (a+b)

a. Central bank Credit to Commercial Sector

b. Other banks Credit to Commercial Sector

3. Net Foreign Exchange Assets of Banking Sector(a+b)

a. Central banks Net Foreign Exchange Assets

b. Other banks net foreign exchange assets4. Net Monetary Liabilities of the Banking Sector(a+b)

a. Net Monetary Liabilities of the Central bank

b. Net Non-Monetary liabilities of Banks

Money Supply(M3) =1+2+3-4


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Commercial Banks

Money(Credit) Supply

Credit Creation

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M0 = C+R+OD ..(1) Reserve Money

where R= RR+ER

M1=C+DD+OD.(2) Narrow Money

R is reserve

RR is Required reserve is the reserve which banks are statutorily

hold with RBI. They have no choice about them.

ER is Excess reserve, all reserves in excess of RR is called as

excess reserve which Banks are free to hold them as cash on hand

with themselves or as balances with the RBI

Since OD is small fraction of total money supply. Its excluded here

High Powered (Reserve) Money,

Money Multiplier and Money Supply


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M0(H) = C+RR+ER ..(1)

M1(M) =C+DD .(2)


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Demand for Money


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Demand for Money

Whats demand???

Demand means the desire and willingness to havesomething with a specific prices at point of time.

What is Demand for money?

Demand for money means the desire and willingness tohave money at specific price a point of time

What determines demand for Money??????

Different schools of thought

Classical Economists

Keynesian Economists

Post Keynesian

Baumol and Tobin

Monetarist Economists

Origin of Demand for Money

Origin is the classical Quantity Theory of Money

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1.Classical Quantity Theory of Money1568 by Jean Bodin French Philosopher

1911 by Irving Fisher: Most popular and represents the classicaltheory

Fishers (1911) QTM:

MV=PQ .(1) Original

MV= PT .(2) Fisher Version

=>P=MV/T(3)

where

M = quantity of money in circulation

P = weighted average price level or general price level

Q= real output

T= sum of all transactions of goods and services per unit time

V = velocity of circulation of money= # times money used to purchase output

Including Money Supply created by banks


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1. Demand for Money: Classical Economists

Laidler, The demand for money depends upon the value of

transaction to be undertaken in the economy and equal to a constantfraction of their transaction

and, Given Money Supply, the equilibrium: MS= Md

)8...().........(,

/,

;

)7...(,.........,

1,),6.........(

1

,,:

1

:..........

YfMSo

kyPMor

TPYwhere

kYMor

VkwhereTkPM

TPV

M

MMandMMiumForEqilibr

TPV

M

ionFisherVersQTMTPVM

d

d

d

d

d

ssds

Md/P is the real cash balance

People need money to buy goods

and services.

So money is demanded for

transaction purpose and it depends

upon level of income

.Demand for Money in Cambridge Version

Here M denotes Money Supply

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2. Keynesian Theory of Demand for Money

People hold money in two alternative form

1. Cash/Currency

2. Bonds or Securities,

So, 3 Motives of holding demand for money

1. Transactions motive

people hold money to buy stuff

Md rises as income rises,

2. Precautionary motive

people hold money for emergencies

car breakdown, Job loss

Md rises with income

3. Speculative motivesuppose store wealth as money or bonds

high interest rates

bonds more attractive, hold less money

Md negatively related to interest rate

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P is fixed in entire Keynesian Models


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1 & 2. Transaction and Precautionary Demand for MoneyMT

d=f(Y).(10)

and MPd=f(Y)(10)

So, MTd=k(Y). (10a) k>0

and MPd=k(Y). (10b) k>0

k is constant proportion of money demand from Real Income for

transaction purpose in transaction demand for money and also

the same in precautionary demand for money.


MTd

Y

Transaction and Precautionary demand for money

is interest inelastic.

Total Money Demand: Md=MTd+Mp

d

=>Md=kY(11)

Md

YQty of money demand for transaction

and precautionary purpose

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3. Speculative Demand for Money

MSpd=f(i) (12) i>0 and Msp

d/ i Mspd=Lo-h*i. (13) Speculative demand for money

h is constant proportion of money demand from interest rates


Liquidity trap means a min rate of interest

beyond which interest rate can not fall and

people wish to hold entire money in idle cash

balance.


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Total Demand for Money: Sum of all these demand functions

We know, MT&Pd=f(Y)

MSpd=f(i) i>0 and Msp

d/ i Md=MTd+Mp

d+Mspd.(14)

=> Md=kY+L0-hi ..(15)

So, Md=f(Y,i) . (16)

Real money demand depends upon real output and overall interest rates.

2.Keynesian Theory of Demand for Money


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Criticism of Keynesian demand for Money

1. Division between Mtd, Mpd and Mspd isunreliable.

2. Normal rate of interest and current rate of

interest are not the same. If current rate of

interest is stable people take it as normal rate of

interest. According to Keynes speculative

demand for money is governed by this

difference.

3. For Keynes only two assets, money or bond.

But in reality people can hold money in different

assets.

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Keynesian theory of Money and Interest RateWe know MT

d+Mspd=Md

Eqm:Ms=Md determines interest rate

=>Mt+Msp=Ms where MS is fixed

=>Md=kY+L0-hi


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Keynesian theory of Money and Interest Rate

Change in Money Market and Interest Rate1. Change in Demand for money

1. Change in Transaction Demand

2. Change in Speculative Demand

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Keynesian theory of Money and Interest RateChange in Money Market and Interest Rate

2. Change in Money Supply


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Thank You All

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3. Friedmans Modern Quantity theory

Milton Friedman (1968) Money is demand just like any other durable goods.

Money as a sterile form of wealth and money isdemanded for storing wealth.

Md as asset demand. wealth

return relative to other assets

Determinants of Demand for Money

Ultimate Wealth Holders Total Wealth: human + non human

Proportion of total wealth to human Wealth (w) Expected rate of return on money (rm) and fixed

assets (rb), equities (re)

Other variables affecting the utility of money (u)


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Yp = permanent income

W= wealth

rb = expected bond return

rm = expected money return

re = expected equity return

e = expected inflation rb - rm = relative return on bonds

e = expected return on goods u=other variables affecting utility of money increase in Yp will increase Md

increase in relative returns of bonds, equity or money decrease Md

Milton Friedman (1968)

Md as asset demand


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1. Classcial Quantity Theory of Money

Now QTM: MV=PT

=>P=MV/T(3)

P M

Irving Fisherrelates quantity of money to nominal income

2 assumptions

V is constant in short-run

depends on institutions, technology thatchange slowly

T is at full employment level (T)

also constant in short-run

_ _

if V, T constant then

A change in M must cause an equal % change in P

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1. Classcial Quantity Theory of Money: TheCambridge VersionDeveloped by Alfred Marshall (1890); Modified by AC Pigou, DH Robertson,

and J M Keynes. Also referred as Neoclassical Theory of Money

According to Cambridge Version, The Price Level is affected by only that part

of Money which People hodl in the form of cash for transaction purpose not

by the total MV as suggested by the classical

So Md= kPQ..(9) Demand for Money in Cambridge Version

P= Price Level

Q= real Income

k = Proportion of money income held for currency and bank deposits

k is difficult to determine

At Eqm: Ms=Md

So, Ms=Md=kPQ

Ms/k= PQ

k=1/v of Fishers equation. SO both k an 1/v are reciprocals.s


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1. Classcial Quantity Theory of Money: The

Cambridge VersionSo Md= kPQ..(9) Demand for Money in Cambridge Version

Adv:

Unlike Fishers eq of exchange, the neo classical theory links prices

to the demand fro money not with the supply of money.

links demand for money with money income

bring how changes in demand for money changes price level

Classical Theory of Interest Rate

Classical theory says equilibrium between Mdand Ms determines Price

level and not the interest rates

But Keynes first developed the theory of interest rate for the classical

economists and said equilibrium between Md and MS determines theinterest rate . This is called as Loanable fund theory of interest rate or

Neo classical Theory of interest rate.

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Thank You All

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Movement of Treasure

Specially built trucks for short distance(journey completed during the day)

Railways for long distance, Guarded bypolice

Remittance accompanied by officials of

RBI to chests

Further movement from chest to a branchdone by the bank concerned

Money Supply Demand

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