Money Supply

Money supply is the amount of money in circulation in the economy at any point of time.   It not only includes the currency & coins in circulation, but it also includes demand & time deposits of banks, post office deposits & the things like that.   Different components of money supply are as under:

M1 = Currency with the public + Net demand deposits of banks + other deposits with RBI
M2 = M1 + Post Office Savings
M3 = M2 + Net Time Deposits

M3 is the level of money supply in an economy at any given point of time.  For details on how the money supply effect an economy, click here

The level of money supply is controlled by the monetary authority in any economy.  In India, RBI performs this function.  At present, money supply growth rate is 15.75% in India, which is too high by any standards.  But in India, a major portion of increase in money supply is used to finance the Government expenditure.  The Government used to fix up its borrowing program & the RBI was supposed to finance it.  This is one area, where the RBI didn't have any control and this was a major issue in Indian economy, as far as the autonomy of the RBI was concerned.

But the situation has changed now.  The RBI has been given enough autonomy to decide the level of finances it will provide to the government.  Initially, the borrowings used to be financed by issue of G - secs & the interest rates to be paid on them was used to be fixed by the RBI.  Now the yields on these G - secs is determined by the market on the basis of competitive bidding.  This helped to put some control on govt. borrowings as the yields on G - secs increased.

Also, the RBI started a new facility, called the Ways & the Means Advances (WMA), according to which, the amount to be provided to the government was fixed for a particular period of time and the repayment has to done at the end of that predetermined time. 

The RBI also controls the money supply by making use of CRR & SLR.  Since liberalization, it has been trying to reduce the CRR & SLR levels.  From their maximum permissible limits (CRR - 15%,SLR-35%), it has brought down CRR to 8% & SLR to 25% at present.  This has increased the liquidity in the system which can be sued to finance the ever increasing government borrowing program without issuing any new currency.

All these measures have, to a large extent, controlled the money supply growth rate which used to be around 25% in early 90s.