Broad money

Topic: Banking, Credit Creation and Monetary Policy · NCERT: Class 12, Ch 3 "Money and Banking"

Meaning

Broad money is the wider measure of money supply. It adds banks' time deposits (fixed deposits locked for a set period) to the most liquid money. In India, the broad money measures are M3 and M4.

• M3 = M1 + net time deposits of banks
• M4 = M3 + total Post Office savings deposits (excluding NSC)

M3 is the measure the RBI and economists use most. It is also called "aggregate monetary resources". It gives the best picture of how much money people hold and how much spending power there is in the economy.

Explanation

What goes into broad money

• Money supply is the total stock of money held by the public at a point in time.

• It leaves out money held by the government and by the banking system itself.

• Liquidity means how easily money can be spent. It falls as you move from M1 to M4.

Measure	Definition	Type
M1	Currency with the public + net demand deposits of banks + other deposits with RBI	Narrow (most liquid)
M2	M1 + Post Office savings bank deposits	Narrow
M3	M1 + net time deposits of banks	Broad, and the most used
M4	M3 + total Post Office savings deposits (excluding NSC)	Broad (least liquid)

• Demand deposits (savings and current accounts) can be withdrawn at any time. That is why they sit in M1.
• Time deposits (fixed deposits) are locked for a period. You cannot spend them at once. That is why they appear only from M3 onwards and make it "broad".
• M4 goes one step further and adds all Post Office savings deposits. So it is the least liquid measure.

How broad money is created: H and the money multiplier

• Money supply = m × H
• H (high-powered money, M0 or reserve money) is the money the RBI itself issues and owes: currency in circulation + bankers' deposits with RBI + other deposits with RBI.

• m (money multiplier) is how many rupees of money are created for each rupee of H.

• Credit creation (how banks turn one deposit into many):

• A bank keeps part of each deposit as reserves and lends the rest.
• The loan is spent and comes back into a bank as a new deposit.

• That deposit is lent again. In the end, total deposits become a multiple of the reserves.

• Worked example (NCERT, CRR 20%):

• Leela deposits ₹100. The bank keeps ₹20 and lends ₹80. The ₹80 returns as a deposit, so deposits become ₹180.
• The series runs 100 + 80 + 64 + 51.2 + … with ratio 0.8.

• Total = 100 × 1/(1 − 0.8) = ₹500. So the simple multiplier is 1/CRR = 1/0.2 = 5.

• Fuller formula (NCERT): m = (1 + cdr)/(cdr + rdr)

• cdr (currency deposit ratio) = cash held by the public ÷ the public's bank deposits.
• rdr (reserve deposit ratio) = the share of deposits that banks keep as reserves.
• Example: cdr = 0.25 and rdr = 0.20 give m = 1.25/0.45 ≈ 2.8.

What makes broad money rise or fall

• A rise in H. H grows when any of its sources grows:
• the RBI's net credit to government (for example, buying government securities);
• the RBI's credit to banks (for example, repo loans);

• net foreign exchange assets (when the RBI buys dollars, it pays out rupees).

• A lower CRR:

• CRR is cut → banks keep less as reserves → the multiplier rises → more loans and deposits → M3 rises.

• Raising CRR from 20% to 25% cuts m from 5 to 4. Maximum deposits fall from ₹500 to ₹400.

• A lower cdr (a stronger banking habit):

• People keep less cash and more in banks → more money comes back to be lent again → m rises.

• Demand for loans: banks cannot lend, and so cannot create deposits, if firms and households do not want to borrow.

• Money moving between deposit types: if people shift money from savings accounts into fixed deposits, M1 falls but M3 stays the same, because M3 counts both kinds of deposit.

In India

• Who measures it: the RBI has compiled monetary statistics since July 1935 [4].

• It works out M3 using a balance-sheet approach. This means it combines the balance sheets of the RBI and the banking sector (commercial and co-operative banks) [4].

• Latest figure: M3 was ₹272.87 lakh crore in 2024-25.

• It was ₹11.24 lakh crore in 1999-2000. That is about a 24-fold rise in 25 years.

• Multiplier in India (2024-25): m = M3 ₹272.87 lakh crore ÷ M0 ₹48.3 lakh crore ≈ 5.6.

• Check with the fuller formula:

  • currency with the public ≈ ₹36.3 lakh crore, deposits ≈ ₹236.6 lakh crore, so cdr ≈ 0.15;
  • bank reserves ≈ ₹10.85 lakh crore, so rdr ≈ 0.046;
  • m ≈ 1.15/(0.15 + 0.046) ≈ 5.8, which is close to 5.6.

• CRR, the main lever on the multiplier: CRR is kept with the RBI as a per cent of NDTL (net demand and time liabilities, roughly a bank's total deposits) [2].

• It was cut to 4.0% of NDTL in December 2024 [5] and now stands at 3.00% [3].

• At 3%, the simple formula 1/CRR would give about 33. The real multiplier is only about 5–6, because the public holds a lot of cash and banks keep extra vault cash. So the fuller formula fits India better.

• Committee link: the Working Group on Money Supply: Analytics and Methodology of Compilation, chaired by Dr Y.V. Reddy, reported in June 1998 [4].

• It proposed new aggregates NM1, NM2, NM3, based on residency and maturity, and liquidity aggregates L1, L2, L3 [4].

Don't confuse with

• Narrow money (M1, M2): narrow money has only the most liquid money (cash and demand deposits, plus Post Office savings bank deposits in M2). Broad money also counts time deposits.
• Reserve money / high-powered money (M0): M0 is the RBI's own liability and the base of the system. Broad money (M3) is built on M0 by bank lending. In 2024-25, M3 was about 5.6 times M0.
• M2 vs M4: both add Post Office deposits. M2 adds them to M1 (narrow). M4 adds them to M3 (broad). Post Office deposits are never part of M1 or M3.
• NM3 and L1–L3 (Y.V. Reddy Group): these are the new monetary and liquidity aggregates proposed in 1998 [4]. They are not the same as the older M3 and M4.

Prelims Hooks

• M1 and M2 are narrow money. M3 and M4 are broad money. Liquidity falls from M1 to M4.
• M3 = M1 + net time deposits of banks, also called "aggregate monetary resources". M4 = M3 + total Post Office savings deposits (excluding NSC).
• Money supply = m × H. In India (2024-25), m ≈ 5.6 (M3 ₹272.87 lakh crore ÷ M0 ₹48.3 lakh crore).
• Trap: "Post Office deposits are part of M3." This is false. They appear only in M2 and M4.
• Trap: "CRR balances can be held in government securities." This is false. CRR is kept with the RBI, and government securities count towards SLR [2].
• The Y.V. Reddy Working Group (June 1998) proposed NM1–NM3 and L1–L3 [4]. The RBI derives M3 using a balance-sheet approach [4].

Mains Points

• The RBI controls broad money only partly.
• The RBI sets H and the CRR (cut to 4% in Dec 2024 [5], now 3% [3]).
• But M3 also depends on how much cash people hold (cdr) and on whether firms and households want to borrow.

• So a CRR cut gives banks more money to lend, but M3 grows only if people actually take loans. This is why policy moves can pass through weakly to the economy (GS-III: monetary policy effectiveness).

• Financial inclusion makes broad money grow faster and monetary policy work better.

• Jan Dhan accounts and digital payments lower cdr → the multiplier rises → more money stays inside banks, where RBI signals can reach it.

• Demonetisation (2016-17) showed a sharp change the other way round: currency with the public fell steeply.

• Broad money connects fiscal, external and monetary policy.

• When the RBI buys government securities or buys dollars (to stop the rupee from rising), H rises, and so does M3 through the multiplier.
• To stop this extra money from pushing up inflation, the RBI may sterilise it, which means soaking it up through OMO sales, MSS bonds or the SDF.

Related concepts

• Credit creation
• Bank balance sheet
• Bank reserves
• Money multiplier
• Currency deposit ratio
• Reserve deposit ratio
• Bank run
• High-powered money
• Currency in circulation
• Money supply

Read more

• Credit creation, high-powered money and the money supply