MONEY SUPPLY [M3]

Question 1

What is M0 (Reserve Money)?

Answer 1

M0 (Reserve Money), also known as High-Powered Money, is the most fundamental measure of the money supply. It includes:

Currency in circulation with the public.
Bank reserves held with the central bank (the RBI in India).

Question 2

What is M3 (Aggregate Monetary Resources)?

Answer 2

M3 is a broader measure of the money supply in an economy. It includes:

M0 (Reserve Money)
Deposits with commercial banks (like demand deposits and time deposits)
Other liquid assets held by the public

Question 3

Define the money multiplier. How is it calculated?

Answer 3

The money multiplier measures how much the money supply expands with every unit increase in reserves (M0) held by banks.

Calculation: Money Multiplier = M3 / M0

Question 4

In 2021, what happened to the money multiplier in India, and what was a likely cause?

Answer 4

The money multiplier decreased in 2021. This was likely because banks struggled to find suitable borrowers, resulting in them depositing excess reserves with the RBI under the Reverse Repo Window.

Question 5

Explain the Reverse Repo Window.

Answer 5

The Reverse Repo Window is a tool the RBI uses to manage liquidity in the banking system. Banks can park their excess reserves with the RBI and earn a rate of return. This helps control inflation and interest rates in the economy.

Question 6

In 2021, how did the growth rates of M0 and M3 in India change compared to 2020?

Answer 6

In 2021, both M0 and M3 increased in quantity, but their growth rates slowed down compared to the previous year (2020).

Question 7

What are the key components that make up M3?

Answer 7

M3 includes the following:

M0 (Currency in circulation + Bank Reserves)
Time Deposits with commercial banks
Demand Deposits with commercial banks
Other deposits with the RBI

Question 8

Why is understanding the money supply (M0, M3) important for economists and policymakers?

Answer 8

Tracking the money supply is crucial because:

Inflation Control: Changes in the money supply can directly influence inflation levels.
Economic Growth: The money supply impacts interest rates and lending activity, influencing economic growth.
Policy Decisions: Central banks use insights about the money supply to make monetary policy decisions.

Question 9

Besides the Reverse Repo Window, what are other tools the RBI can use to influence the money supply?

Answer 9

The RBI has several tools at its disposal:

Repo Rate: The interest rate at which RBI lends to banks.
Open Market Operations: Buying or selling government securities.
Reserve Requirements: Adjusting the percentage of deposits banks must hold as reserves.