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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
_
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.
2. Keynesian Theory of 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
2. Keynesian Theory of Demand for Money
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
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