MONEY AND

MONEY SUPPLY
What is Money?
Some of the widely accepted definitions:
Money is what money does.
Anything which the state declared as money is money.
The means of valuation and of payment; as both the unit
of account and the generally acceptable medium of
exchange.
Currency and demand deposits, and its most important
function is to act as a medium of exchange.
It is the sum of currency plus all adjusted deposits in
commercial banks.
Any asset capable of serving as a temporary abode of
purchasing power.


Money is anything that is generally accepted in
Payment for goods and services and in
settlement of debt obligations.

The main functions of money are:
Unit of account/measure of value
Medium of exchange
Store of value
Transfer of value

Money supply
Stock of money held by the public in a spendable form
Aggregate stock of domestic money owned by the
public in the country
Total stock and supply of money in circulation at any
moment
Total money supply in a country comprises:
i) currency money- metallic coins and paper notes
issued by the central bank or Central Govt. and
circulating in the country
ii) demand/time deposits held by the public with the
commercial banks

Money stock measures in India are classified as:
M1 = currency with the public + deposit money of the public
(demand deposits with banks + other
deposits with RBI)
M2 = M1 + Post office savings deposits
M3 = M1 + Time deposits with banks
M4 = M3 + Total post office deposits
M1 is the narrow money and M3 is the broad money
Is computed by the aggregation of net bank credit to
govt., Bank credit to commercial banks, net foreign
exchange assets of the banking sector and Govt.
currency liabilities to the public less non-monetary
liabilities of the banking sector

Measures of money
Primarily there are three money
creating institutions in a country

i) Treasury

ii) Commercial banks

iii)Central bank

Changes in the money supply are
due to actions of these institutions
The demand for money
Two different concepts of demand for money:

Medium of exchange concept of the demand for
money-CLASSICAL VIEW

Store of value concept of the demand for money-
MODERN VIEW

CLASSICAL VIEW
Money is not demanded for its own sake
Demand arises on account of exchange transactions,
from the demand for goods and services
Depends upon the supply of exchangeable goods and
services available in the market which is not constant
So is demand for money which varies from time to time
and determined exclusively by objective factors such
as volume of exchange transactions

Equation of Exchange is MV=PT
M=total quantity of money, V=velocity of circulation
P=price level, T= total amount of goods and services
exchanged for money


Velocity of circulation of money
A unit of money may be spent several times during
given period of time

Average number of times money is transferred from
one person to another in a given period of time is
known as velocity of circulation of money

Hence total supply of money in a given period is
total amount of money in circulation multiplied by its
velocity of circulation
MODERN VIEW also known as Keynes view

Demand for money means the demand to hold
money or cash balances

Also known as liquidity preference which is the
demand for liquidity or cash, desire to hold
assets in cash

Sources of demand for money:
1. Transactions motive
2. Precautionary motive
3. Speculative motive
Motives behind liquidity preference
Transaction motive/demand
is the need of cash for the current transactions of
personal and business exchange
Further split as
i) business motive : to bridge the interval between the time of incurring business
costs and receipt of sale proceeds- transaction motives of businessmen,
industrialists, traders, merchants, etc. who require certain amount of money in
order to carry on their day-to-day business
ii) income motive: to bridge the interval between the receipt of income and its
disbursement- transaction motive of the consumers who require cash
balances to make day-to-day purchases of goods and services for
consumption
Transaction demand for money is directly proportional and
positive function of the level of income.
Depends on two things: i)on the business turnover ii) on
the timing and size of personal incomes
Precautionary motive/demand
Desire to provide for contingencies requiring sudden
expenditure and for unforeseen opportunities of
advantageous purchases
Both individuals and businessmen keep cash in
reserve to meet unexpected needs
Represents the store of value function of money
Depends on uncertainty of future
Depends upon:
level of income
business activity
opportunities for unexpected profitable deals
availability of cash
cost of holding liquid assets
Speculative motive/demand
A liquid store of value which can be invested at
an opportune moment in interest bearing bonds
and securities
Objective is for speculative purposes with a view
to earn income
Uncertainty of future rate of interest causes
demand for money for the speculative motive
A decreasing function of rate of interest higher
the rate, lower the demand for money and lower
the interest, higher the demand for money
Is highly volatile depending upon the behaviour
of interest rates
Total demand for money
According to Keynes,
Transaction motive and precautionary motive is
primarily a function of level of income, while the
speculative demand is the function of rate of
interest
Thus total demand for money is a function of
both income and interest rates.