Money Market

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Money Market
(Money and Banking)

What is Money?
A financial asset with the following functions:

Medium of exchange:
An asset that individuals acquire for the purpose of trading rather than for their own consumption.

A store of value:
Means of holding purchasing power over time

A measure of value (unit of account):
Measure used to set prices and make economic calculations
2

What is money?
Money is anything that serves as a commonly accepted medium of exchange Money and Income What we earn is income, not money Money is used to pay the income

Most liquid Currency Transaction deposits Very liquid Saving deposits Short-term securities Money-market funds Less liquid Long-term bonds Equities Real assets

Money Supply
Narrow (Transactions) Money (M1) = Coins and paper currency + Demand Deposits (or Checkable Deposit), Traveler’s Checks, etc. (‘Other’ deposits with RBI (= deposits of UTI, IDBI etc; deposits of foreign central banks/governments etc.) are also a part of M1; statistically very small)

Broad Money (M3) = M1 + time deposits with banks
(Money supply in India usually refers to M3)

Also:

M2 (Near-Money) = M1 + savings deposits of post office
savings bank M4 = M3 + total deposits with post office savings banks

M1: Rs 1253184 crores, March 2009
Currency with the public ‘Other’ deposits with the RBI 1% Demand deposits

46% 53%

5

M3: Rs 4764019 crores, March 2009
Currency with the public Time deposits
0% 14%

Demand deposits ‘Other’ deposits with the RBI

12%

74%

6

Money Stock Measures
(Rs. Billion)

Currency with the Public

Deposit Money of the Public Post Total Office Time Post M1 Saving M2 Deposit M3 M4 Office (5+8) Bank (9+10) s with (9+12) (13+14) Depo Deposit Banks sits s

Circulation Cash ‘Other’ of Notes Deman on Deposit Period in Total d Hand s with Total Circula Rupee Small (1+2 Deposit with Reserve (6+7) -tion Coins Coins +3-4) s with Bank Bank (1) Banks (2) (2) s (3) 1 2008-2009 6,811.0 2 84.9 3 15.7 4 257.0 5 6,654.5 6 5,886.9 7 55.7 8

9

10 50.4

11

12

13

14

15

5,942.6 12,597.1

12,647.5 35,351.0 47,948.1 259.7 48,207.8

2009-2010

7,882.8

97.0

15.7

320.6

7,674.9

7,179.7

38.4

7,218.1 14,893.0

50.4

14,943.4 41,134.3 56,027.3 259.7 56,287.0

2010-2011

9,369.4

111.6

15.7

354.6

9,142.0

7,176.6

36.5

7,213.1 16,355.1

50.4

16,405.5 48,639.8 64,994.9 259.7 65,254.5

7

Who Determines Money Supply?
Central Bank (RBI):
– Determines the monetary base (M0) (also known as reserve money, base money, high powered money etc.) by fixing the cash reserve ratio, bank rate, etc.

Commercial Banks:
– Create money through multiple expansion of bank deposits based on cash reserves (credit money)

General Public:
– Through transactions/exchange of money

Central Bank and Money Supply
Central Bank (Reserve Bank of India, Federal Reserve
System in USA) oversees and regulates the banking system and controls the money supply by determining the monetary base

Three primary functions of the Central Bank:
1)

Regulates banks to ensure they follow the laws intended to promote safe and sound banking practices. Acts as a banker’s bank, making loans to banks and as a lender of last resort.

2)

3)

Conducts monetary policy by controlling the money supply

Central Bank and Money Supply
Money Multiplier Approach
Monetary liabilities of RBI:
– Currency issued by the RBI (notes of rupees two and above) – Reserves held by the commercial banks with the RBI, and – Other deposits with the RBI

Central Government also issues money in the form of onerupee notes, coins and small coins (the share is negligible)

Money Multiplier Approach
The monetary liabilities of the RBI plus Government money is known as ‘High Powered Money’ (H), also called ‘Reserve Money’ or ‘Monetary Base’ or M0 Therefore, H = currency with the public (C) + Reserves (R) + Other...
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