Explanation
Money refers to a common medium of exchange that is issued under the law of government and acts as a legal tender for the whole country. The functions of money can be classified into two categories:
1. Primary function: The primary function of money includes money as a medium of exchange and money as a measure of value.
2. Secondary function: The secondary function of money includes money as a store of value and money as a standard of deferred payment.
Therefore, power indicator is not a function of money.
Money supply refers to the total stock of money of all types ( currency as well as demand deposits) held by the people of a country at a given point of time.
Money supply is measured in several ways which includes M1, M2, M3 and M4 measurement of money supply. Every measurement has it own definition with different components varying from most liquid to most rigid form.
M4 measurement of money supply is the least liquid money supply in India as it includes all the other deposits of post office savings other than national savings certificate.
M4 = M3 + Total deposits with post offices other than in the form of national saving certificate
In which, M3 = C+ DD+ OD + net time deposits with the commercial banks
where,
C: It refers to currency held by public in terms of coins and paper notes.
DD: It refers demand deposits of the people with the commercial bank.
OD: These includes other deposits with public financial institution, foreign central banks and international financial institution.
M1 measurement of money supply is the most liquid money supply in India as it just includes currency held by the public in terms of coins and paper notes, demand deposits of the people with the commercial banks and some other deposits with other financial institutions.
M1= C+ DD+ OD
Moral suasion refers to the persuasion and pressure which central bank exert on the commercial banks in order to follow the directives of its monetary policy. These are generally not ignored by the member banks as it comes directly from the upper authority. The banks are advised to restrict the flow of credit during inflation and be liberal in lending during deflation.
In India, other deposits of post office savings other than national savings certificate are included in M4 measurement of money supply which makes it a most rigid form of money supply in terms of liquidity. M4 measurement of money supply includes:
Demand deposits refers to the deposits of the people which is held by the commercial banks which can be withdrawn on demand. These are included in M1 and M2 measurement of money supply as they are considered the liquid money supply in the economy.
(i) Increase in CCR: Cash Reserves Ratio (CRR) refers to the proportion of total deposits of the commercial banks which they must keep as reserves with the central bank in the form of cash. By increasing the cash reserve ratio, the commercial banks has to maintain more cash with the central bank which reduces their credit creation capacity and therefore money supply in the economy also reduces which corrects the situation of inflation.
(ii) Increase in SLR: Statutory Liquidity Ratio (SLR) refers to liquid assets i.e. cash which the commercial banks must hold with themselves on a daily basis as a portion of their total deposits. By increasing the statutory liquidity ratio, the commercial banks has to maintain more cash with themselves which reduces their credit creation capacity and therefore money supply in the economy also reduces which corrects the situation of inflation.
(iii) Issuing bonds in open market: Open market operation (OMO) is a monetary policy by the central bank in which the bank deals in the sale and purchase of securities and bonds in the open market to control the supply of money in the economy. By issuing the securities and bonds, the central bank soaks liquidity from the economy that reduces the purchasing power in the economy which controls the situation of inflation.
M3 measurement of money supply is a broader concept of money supply compared to M1. Besides all the components of M1, it includes net time deposits (or fixed deposits or term deposits) of the people with the commercial banks. Therefore, M3 is also called broad money.
Money as a standard of value or measure of value refers to that function of money which helps in determining the value of goods and services in the economy. Money is taken as the common denominator while measuring the value of goods and services in monetary terms according to which prices are measured for all commodities in the economy.
Cash Reserves Ratio (CRR) refers to the proportion of total deposits of the commercial banks which they mus keep as reserves with the central bank in the form of cash. Cash reserve ratio is determined by central bank so that they can control the amount of credit creation of the commercial banks at the time of inflation or deflation in the economy. By increasing the cash reserve ratio, the commercial banks has to maintain more cash with the central bank which reduces their credit creation capacity and therefore money supply in the economy also reduces which corrects the situation of inflation and by decreasing the cash reserve ratio, the commercial banks has to maintain less cash with the central bank which increases their credit creation capacity and therefore money supply in the economy also increases which corrects the situation of deflation.
Cheap money policy refers to a monetary policy by the central bank where the central bank sets low interest rates so that credit is easily available to the general public in order to bring efficiency in trade and commerce in an economy. Such a policy is used by the government at the time of deflation or recession in the economy in order to reverse depression from the economy as such a policy increases the purchasing power of the people by increasing the money supply in the economy.
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