M0: CREATION OF MONEY Flashcards
What is M0, and how is it created?
M0 is a measure of the most basic form of money supply in an economy. It’s also known as Reserve Money, Government Money, or High Powered Money. M0 is issued by the Reserve Bank of India (RBI) under the RBI Act, through the RBI’s Issue Department. The Issue Department must hold assets equal to the value of the M0 issued, ensuring the currency has proper backing.
List the different types of assets that can be held by the RBI’s Issue Department.
Rupee coins
Gold coins (with a minimum value of ₹200 crores)
Gold bullion (with a minimum value of ₹115 crores)
Foreign securities (including those from the IMF)
Indian Government securities
What are the liabilities of the RBI’s Issue Department?
Total banknotes in circulation (held by the public and banks as vault cash)
Other deposits held by the RBI (from the public, banks, and the government). An example is the PM Garib Kalyan Yojana deposit scheme.
Explain how the RBI’s purchase of government securities affects the M0 money supply.
When the government borrows money from the RBI by selling government securities, the RBI pays for them by issuing new currency. This increases the assets of the RBI’s Issue Department, and in turn, increases the M0 money supply.
Have the minimum requirements for gold and foreign securities held by the RBI changed over time?
Yes. The minimum requirements for gold coins and bullion have been reduced over time. Additionally, after 1995, there is no longer a minimum requirement for the RBI to hold foreign securities.
Why does the RBI need to ensure its assets match its liabilities?
The balance between the RBI’s assets and liabilities is essential for maintaining the stability and credibility of the nation’s currency. By holding assets to back up money issued (M0), the RBI ensures there are sufficient resources to support the value of the currency in circulation, maintaining trust in the monetary system.
Explain the role of rupee coins in the M0 money supply, and how the RBI puts them into circulation.
Rupee coins are a component of M0. The RBI doesn’t directly mint coins – it acts as the government’s agent. The government mints coins, and the RBI ‘buys’ the coins and distributes them into circulation.
Why might the government borrow money from the RBI? What are the implications for the money supply?
The government may borrow from the RBI to cover budget deficits or finance development projects. When this occurs, the RBI purchases government securities, increasing its assets. This leads to the creation of new money, thus increasing the M0 money supply.
What factors besides government borrowing can influence the M0 money supply?
Other factors include:
Foreign Exchange Transactions: When the RBI buys foreign currency, it increases M0, and when it sells foreign currency, it reduces M0.
Open Market Operations (OMO): When the RBI buys government securities from banks in the open market, it increases M0, and when it sells, M0 decreases.
Can you think of a real-world scenario where understanding M0 and its creation would be important for economic analysis?
Yes! Suppose an economist is analyzing the cause of inflation in an economy. Understanding changes in M0 is crucial because excessive growth of the money supply can fuel inflation.
