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Money is the backbone of an economy. It is generally accepted as an exchange medium and used as a value measure. Money can be used to complete a business transaction and settle business loans. It includes cheques, coins, currency notes, etc.

One of the important aspects is its supply in an economy. In this article, we will discuss the measures of money supply in India and its importance alongside different components of measuring money in an economy.

The Reserve Bank of India (RBI) in 1977 introduced four components for money supply; M1, M2, M3 and M4. It is the combined amount of liquid assets and currency in a country’s economy on a given date.

This includes all notes, coins and demand deposits held by the public. Simply put, it is the total stock of money in an economy that is circulated on any specific date.

However, while calculating the money supply, money that is kept as stock with the government or central bank is not considered in money supply. It is because this money is not a part of the circulation in an economy.

In addition, there are three main sources of money supply in the Indian economy. These sources produce all the money in the economy and are responsible for distribution purposes. They are:

• The Government of India produces all coins and rupee notes.
• The Reserve Bank of India issues all paper currencies in the economy.
• Commercial Banks create credit according to the demand deposits.

If a measure of money supply is not done, the economy poses a risk of inflation or recession. It is important to measure the money supply in India so that the government and banks can ensure sufficient liquidity in the economy to meet the demand for funds.

The government can modify supply if they know the current money supply in an economy through monetary policy. If the money supply is too low which puts the economy at risk of recession, the government can use monetary policy to increase the supply.

Similarly, if the money supply is too high, which might lead to inflation, a monetary policy can be used to control and decrease the supply.

1. M1

M1, or Narrow money, includes all currency notes that are held by the public on a given day. It also includes all demand deposits that banks hold in an economy. It could be both savings and current account deposits. M1 also includes other deposits that are with the RBI. All these components are easily used as a medium of exchange, making it the most liquid money supply measure.

M1= Coins and currency notes held by the public + Commercial bank held demand deposits + Other deposits kept with RBI

2. M2

It is the second measure of money supply and has a broader concept than M1. This measure includes M1 and saving deposits of post office banks. You cannot simply withdraw savings deposits with a post office savings bank. Therefore, such deposits are not considered among deposits with the bank. This led to the evolution of the M2 measure of the money supply.

M2= M1 + Savings deposits of post office bank

3. M3

M3 is a much broader concept when compared to M1. It includes all currency notes and coins held by the public and demand deposits held by commercial banks. This concept also includes deposits of commercial banks kept with the RBI and net time deposits of all banks in India.

M3= M1 + Net time deposits of all commercial banks

4. M4

M4 is India's most widely used measure that the RBI uses to measure money supply. It includes all components of M3 and total deposits with the post office savings bank. However, it does not include the National Saving Certificate (NSC).

M4= M3 + Total deposits with post office saving bank