Narrow Money and Broad Money JAIIB CAIIB Bank Promotions

Narrow Money (M1)

At any point of time, the money held with the public has two most liquid components

  • Currency Component: This consists of all the coins and notes in the circulation
  • Demand Deposit Component: Demand Deposit component is the money of the general public with the banks, which can be withdrawn by them using cheques, withdrawals and ATMs.

The above two components i.e. currency component and demand deposit component of the public money is called Narrow Money and is denoted by the RBI as M1. Thus,

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M1 = Currency with the public + Demand Deposits of public in Banks

When a third component viz. Post office Savings Deposits is also added to M1, it becomes M2.

M2 = M1 + Post Office Savings.

Indian Financial System

Broad Money

Narrow money is the most liquid part of the money supply because the demand deposits can be withdrawn anytime during the banking hours. Time deposits on the other hand have a fixed maturity period and hence cannot be withdrawn before expiry of this period. When we add the time despots into the narrow money, we get the broad money, which is denoted by M3.

M3 = Narrow money + Time Deposits of public with banks

We note here that the Broad money does not include the interbank deposits such as deposits of banks with RBI or other banks. At the same time, time deposits of public with all banks including the cooperative banks are included in the Broad Money.

Now, we understand that the major distinction between the M1 and M3 is “Treatment of deposits with the banks”. If we go a little deep, the M3 is the treatment of “Time Deposits” of the public, since demand deposits are available against cheques and ATMs.

When you add the Post Office Savings money also into the M3, it becomes M4.

SARFAESI ACT

Both M2 and M4 which include the Post office Savings with narrow money and broad money respectively are now a days irrelevant. Post Office savings was once a prominent figure when the banks had not expanded in India as we see them today all around. The RBI releases the data at times regarding the money supply in India and Post Office Savings Deposits have not been updated frequently. There is NOT much change in the money of people deposited with the Post office and RBI did not care to update this money. Further, there was a time when the Reserve Bank used broad money (M3) as the policy target. However, with the weakened relationship between money, output and prices, it replaced M3 as a policy target with a multiple indicators approach. RBI started using the Multiple Indicator Approach since 1998

Currently, Narrow Money (M1) and Broad Money (M3) are relevant indicators of money supply in India. The RBI in all its policy documents, monthly Bulletins and other documents shows these aggregates.

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