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Unit 5: Monetary Policy

Introduction Notes

Monetary policy is all about supply of currency in the country. If we are talking about supply of
currency then the term has a wide meaning, since the supply of currency is affected by many
means and in turn , affects many other variables many. It is a country's central bank that controls
the supply of money. Monetary policy has direct bearing on inflation and commercial bank
interest rate. So even the slightest change in the monetary policy affects inflation and bank
interest rate.

5.1 Monetary Policy

The central bank designs the monetary policy in keeping with the government's economic
policy. Monetary policy is about expansion and contraction of money and the central bank is the
implementing body of the monetary policy. Given below is the study of money supply and our
central bank, i.e., the Reserve Bank of India (RBI).

5.2 Measures of Money Supply in India (Monetary Aggregates)

There are two basic measures of money globally: narrow and broad. The former usually consists
of the currency with the public and demand deposits with banks. The latter includes the time
deposits with banks. Till 1998, the RBI calculated four components of money supply in India,
now termed as old money measures. These are known as money stock measures of monetary
aggregates.

Old Money Aggregates/Measures are as follows:
M = Currency with the public, i.e., coins and currency notes + Demand Deposits
1
with banks + Other deposits with RBI.
M = M + Post Office savings.
2 1
M = M + Time deposits of the public with banks; this is also known as broad
3 1
money.
M = M + Saving and time deposits with the post office.
4 3
Out of the four concepts of money supply, RBI emphasises only two concepts, viz., ordinary
money or narrow money (M ) and money supply in the broad sense (M ), which consists of M
1 3 1
plus time deposit of people with the bank. M is also referred to as broad money or aggregate
3
monetary resource of the people.
New Monetary Aggregates

M = Currency in Circulation + Bankers Deposits with the RBI + 'Other' Deposits
0
with the RBI.
M (NM ) = Currency with the Public + Demand Deposits with the Banking System +
1 1
'Other' Deposits with the RBI.
M (NM ) = M + Time Liabilities Portion of Savings Deposits with the Banking System +
2 2 1
Certificates of Deposit issued by Banks + Term Deposits of residents with a
contractual maturity of upto and including one year with the Banking System
(excluding CDs).
M (NM ) = M + Term Deposits of residents with a contractual maturity of over one year
3 3 2
with the Banking System + Call/Term borrowings from 'Non-depository'
Financial Corporations by the Banking System.

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