Money Supply in India: M0, M1, M2, M3 and M4 – Notes with PYQs

How much money is there in India? The answer depends on what you count as money. Cash is money. A bank deposit is also money, because you can spend it. The Reserve Bank of India (RBI) counts money in four ways. These are called M1, M2, M3 and M4. There is also M0, the base of all money. Exams ask what each measure includes and which one is used most. This post explains them in simple words. It ends with 15 previous year questions.

1. What is money supply?

Money supply is the total stock of money held by the public at a point of time. The public means households and firms. It does not include the government and the banks, because they create money.

Money supply is a stock. It is measured on a date, not over a period. This is different from income, which is a flow.

The RBI tracks money supply closely. Too much money can cause inflation. Too little can slow down growth. So the RBI uses its monetary policy tools to control it.

2. The four measures of the RBI

In 1977, a working group of the RBI set out four measures of money supply. They are M1, M2, M3 and M4. Each one is wider than the one before.

Currency with the public means notes and coins in circulation, minus the cash held by banks.

Demand deposits are deposits you can withdraw at any time, such as current and savings accounts.

Time deposits are fixed for a period, such as fixed deposits and recurring deposits.

Other deposits with the RBI are small. They are deposits of bodies like the IMF, foreign central banks and some financial institutions. Deposits of the government and banks are not counted here.

3. Narrow money and broad money

M1 is called narrow money. It includes only the most liquid forms. Cash and demand deposits can be spent at once.

M3 is called broad money. It adds time deposits. A fixed deposit is not cash. But it can be turned into cash fairly easily. So it is still money in a broad sense.

Liquidity falls as you move from M1 to M4. So the order of liquidity is M1 > M2 > M3 > M4. The order of size is the reverse. M4 is the largest.

In practice, M3 is the most used measure. The RBI reports it every fortnight. When news reports say "money supply grew by 10 per cent", they usually mean M3. M3 is also called aggregate monetary resources.

M2 and M4 are rarely used today, because post office deposits are small and are not updated often.

4. M0 - reserve money

M0 is the base of the whole system. It is called reserve money, base money or high-powered money. It is the money created directly by the RBI.

M0 = currency in circulation + bankers' deposits with the RBI + other deposits with the RBI.

Note the difference from M1. M0 counts all currency in circulation, including cash held by banks. It also counts the reserves banks keep with the RBI. M1 counts only the currency with the public and the deposits of the public.

M0 is called high-powered because banks lend on the basis of it. One rupee of reserves supports many rupees of deposits.

5. The money multiplier

Banks create money by lending. When a bank gets a deposit, it keeps a part as reserve. It lends the rest. The borrower deposits the loan in a bank. That bank lends again. So one deposit grows into many.

The money multiplier shows how much broad money is created from one unit of reserve money.

Money multiplier = M3 / M0.

In India this ratio has usually been around five to six. The exact value changes with time, so do not memorise a single number.

The multiplier falls when banks must keep more reserves. So a higher Cash Reserve Ratio (CRR) reduces the multiplier. It also falls when people hold more cash and deposit less.

6. New monetary aggregates

In 1998, a working group headed by Y. V. Reddy reviewed these measures. It proposed new aggregates. They are called NM1, NM2 and NM3.

• NM1 is close to the old M1.
• NM2 adds short-term time deposits of up to one year.
• NM3 adds long-term time deposits and call borrowings from non-bank sources.

The group also proposed liquidity aggregates, called L1, L2 and L3. These add post office deposits, deposits with financial institutions and public deposits with non-banking financial companies.

Exams mostly ask about the old M1 to M4. But a question on the 1998 working group or NM3 does appear now and then.

7. Money supply and the economy

When money supply grows faster than output, prices rise. This is inflation. When money supply grows too slowly, demand falls and growth slows.

The RBI changes money supply through the repo rate, the CRR, the SLR and open market operations. A higher CRR or a sale of government bonds pulls money out. A lower repo rate or a purchase of bonds pushes money in.

Money supply also grows when the RBI buys foreign currency. The RBI pays in rupees, and these rupees add to M0.

So money supply, prices and RBI policy are linked. A question on one often tests the other two.

8. Previous year questions

1. Which measure of money supply is called narrow money? – M1
2. Which measure of money supply is called broad money? – M3
3. What does M1 include? – Currency with the public + demand deposits with banks + other deposits with the RBI
4. M3 is equal to M1 plus what? – Time deposits with banks
5. M2 is equal to M1 plus what? – Savings deposits with post office savings banks
6. M4 is equal to M3 plus what? – All deposits with post offices, excluding National Savings Certificates
7. Which measure of money supply is also called aggregate monetary resources? – M3
8. What is M0 called? – Reserve money, base money or high-powered money
9. Who creates reserve money (M0)? – The Reserve Bank of India
10. Arrange M1, M2, M3 and M4 in decreasing order of liquidity. – M1 > M2 > M3 > M4
11. How is the money multiplier calculated? – M3 divided by M0
12. In which year did the RBI working group give the M1 to M4 measures? – 1977
13. Who headed the 1998 working group that proposed the new monetary aggregates? – Y. V. Reddy
14. Is money supply a stock or a flow? – A stock
15. Which measure of money supply is published most often and used for policy? – M3

9. How to revise this topic

Start with the table of M1 to M4. Write it from memory until you get it right.

Next, fix the names: M1 narrow, M3 broad, M0 reserve or high-powered.

Then learn the two orders: liquidity M1 to M4 falls, size M1 to M4 rises.

Finally, note the two years and one name: 1977 working group, 1998 working group, Y. V. Reddy.

10. Frequently Asked Questions

What are M1, M2, M3 and M4?

They are the four measures of money supply used by the RBI since 1977. M1 is currency with the public plus demand deposits and other deposits with the RBI. M2 adds post office savings deposits. M3 adds time deposits with banks. M4 adds all post office deposits except National Savings Certificates.

What is narrow money and broad money?

M1 is narrow money, because it includes only cash and demand deposits that can be spent at once. M3 is broad money, because it also includes time deposits such as fixed deposits.

What is M0 or reserve money?

M0 is the money created by the RBI. It is currency in circulation plus bankers' deposits with the RBI plus other deposits with the RBI. It is also called base money or high-powered money.

Which measure of money supply is used most?

M3 is the most used measure. The RBI publishes it every fortnight, and it is also called aggregate monetary resources.

What is the money multiplier?

It is the ratio of broad money to reserve money, that is M3 divided by M0. It shows how much money banks create from one unit of reserve money. A higher CRR lowers the multiplier.

For more Economy topics in simple language, see our Money and its Functions, Monetary Policy, Repo Rate, CRR and SLR and Inflation posts, or browse the Economy section. Preparing for a banking exam? Start with the RBI Assistant guide or join the 100 Hour GS Course.