6 Things You Need to Know About Money

For something we base a lot of our decisions off of, money is surprisingly too-less talked about. For the different aspects associated with money - money supply, fiat money, and even the technical term ‘money’ - there is a need for demystifying the usage and context of such terminology. Here’s five things to know about money supply.

1. All money is created as debt 

The measures of money supply in India are classified into four categories M1, M2, M3 and M4 along with M0. This classification was introduced in April 1977 by the Reserve Bank of India. All the money held with the public, RBI as well as the government is called Total Stock of Money. The other forms - M0, M1, M2, M3, M4 - basically measure how "portable" wealth exists at a certain minimum level of liquidity in terms of its convertibility into cash.

2. The total stock of money in circulation among the public at a particular point of time is called money supply.

This money is in the form of coins, notes and balances held in current and savings accounts. Government issues one-rupee notes and all other coins, RBI issues paper currency and commercial banks create credit based on the demand deposits. This is also known as M0 which is material currency (cash itself); all notes, coins, specie and bearer certificates convertible on demand (which includes, by definition, depositor reserves of banks which must be kept in physical cash).

3. M0 is known as Reserve Money 

It is also known as High-Powered Money, monetary base, base money etc. M0 = Currency in Circulation + Bankers’ Deposits with RBI + Other deposits with RBI. It is the monetary base of the economy.

4. M1 is known as Narrow Money 

M1 includes M0 plus the balance of all deposit accounts which can be instantly converted into cash of equal value (known as "cash equivalent"). This is more than M0 (up to 10 times M0 in fact) because a fundamental principle of economics is that there doesn't have to be enough paper money in existence to cover everyone's bank deposits, because the entire economy won't want their accounts cashed and closed at the same time. So, M1 includes some "fake money", but in the working economy it changes hands as if it were physical cash.

5. Money can also be a function of time. 

M2 is M1 plus all other depositor accounts that can be readily (within 30 days) converted to physical cash of equal value (known as "near-cash"). This includes all savings, money market etc. accounts, and also certain short-term investments. So, this is wealth that may not be instantly convertible, but can be guaranteed to retain its worth during a conversion happening very soon. This measure of money is not commonly referenced anymore because the 30-day period is seen as arbitrary; if there's any restriction on conversion to cash, it's not guaranteed to be "instantly available" and so not cash equivalent; any subdivision beyond that is just a function of time.

6. M3 is known as Broad Money 

M3 is M2 plus all other investment instruments that can be converted into cash, but which may have significant restrictions on a timely conversion and/or a lack of guarantee that the investment's stated worth will be retained in the conversion to cash. So, M3 also includes the worth of the equity and bonds markets denominated in a particular currency, as well as the value of some types of futures contracts and options and virtually all "institutional" investments (as regulations often prohibit the "dumping" of such large holdings onto the market in one transaction, and even if allowed would likely not result in an equitable conversion to cash). It's the widest classification of "money" typically used, as beyond this point it becomes hard to tell the real difference, in a worth and convertibility perspective, between stores of value and fixed assets. Lastly, M4= M3 + total deposits with the post office savings organization.