Money Supply and Inflation
Money Supply and Inflation
What is Money?
Money is anything that is widely accepted as a medium of exchange for goods and services. It also serves as a unit of account, a store of value, and a standard of deferred payment. Modern economies use currency notes and coins, along with digital money, as the most common forms of money.
Money Supply
Money supply refers to the total stock of money circulating in an economy at a particular point in time. It includes currency held by the public and demand deposits with banks. In India, the Reserve Bank of India (RBI) measures money supply in different categories:
- M1: Currency with public + demand deposits + other deposits with RBI
- M2: M1 + savings deposits with Post Office Savings Banks
- M3: M1 + time deposits with banks (widely used indicator)
- M4: M3 + total deposits with Post Office Savings Banks (excluding National Savings Certificates)
Example:
If currency with the public is ₹5,00,000 and demand deposits are ₹2,00,000, then:
M1 = ₹5,00,000 + ₹2,00,000 = ₹7,00,000
Inflation
Inflation is the rate at which the general level of prices for goods and services rises, eroding purchasing power. It is measured as an annual percentage increase.
Mathematical Example:
If the price of a product last year was ₹100, and this year it's ₹110, then inflation rate is:
Inflation Rate = [(110 - 100) / 100] × 100 = 10%
Causes of Inflation
- Demand-Pull Inflation: Occurs when demand exceeds supply. Example: Festive season demand surge.
- Cost-Push Inflation: Occurs due to increased production costs like wages or raw materials.
- Monetary Inflation: Happens when money supply increases faster than economic output.
- Imported Inflation: Caused by rising prices of imported goods like oil.
- Structural Inflation: Due to supply-side inefficiencies and lack of infrastructure.
Measures of Inflation
Inflation is measured using price indices:
- Consumer Price Index (CPI): Tracks prices of goods and services consumed by households.
- Wholesale Price Index (WPI): Tracks prices of goods at the wholesale level.
Example:
If CPI last year was 200 and this year it's 220, then:
Inflation Rate = [(220 - 200) / 200] × 100 = 10%
Control Measures for Inflation
- Monetary Measures: RBI can raise interest rates or reduce money supply.
- Fiscal Measures: Government may reduce spending or increase taxes.
- Supply-Side Policies: Improving production and infrastructure.
- Price Controls: Imposing price caps or subsidies on essential goods.
Example: If RBI increases the repo rate from 6% to 6.5%, loans become more expensive. This reduces borrowing and spending, helping to control inflation.
| Chapter Number | PAPER I – INDIAN ECONOMY & INDIAN FINANCIAL SYSTEM MODULE B: ECONOMIC CONCEPTS RELATED TO BANKING |
|---|---|
| 1. |
MODULE B: ECONOMIC CONCEPTS RELATED TO BANKING Fundamentals of Economics, Microeconomics, Macroeconomics, Types of Economies, and Supply & Demand |
| 2. | Money Supply and Inflation |
| 3. | Theories of Interest - Explained with Examples |
| 4. | Business Cycles and Economic Policies - Explained with Examples |
| 5. | National Income, GDP and Union Budget - Explained with Examples |
| QandAs/MCQs 8 | MCQs: Economics Fundamentals, Micro and Macro Concepts |
| QandAs/MCQs 9 | MCQs on Money, Money Supply, and Inflation |
| QandAs/MCQs 10 | MCQs on Theories of Interest - IS-LM, Classical & Keynesian Theory |
| QandAs/MCQs 11 | MCQs: Business Cycle, Policies, National Income |
| QandAs/MCQs 12 | MCQs: Monetary & Fiscal Policy | National Income | Union Budget |
| MODULE C: INDIAN FINANCIAL ARCHITECTURE | |
| MODULE D: FINANCIAL PRODUCTS AND SERVICES | |
| MODULE A: INDIAN ECONOMIC ARCHITECTURE | |
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