Money supply

Also called: Stock of money, Supply of money, money stock · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Class 10, Ch 3 "Money and Credit"; Class 11, Ch 6 "Correlation"; Class 12, Ch 3 "Money and Banking"

Meaning

Money supply is the total stock of money held by the public (households and firms) at a given point in time. It does not include money held by the government or by the banking system itself.

• Formula: Money supply = m × H
• H is high-powered money (the base money created by the RBI).
• m is the money multiplier (how many rupees of money are built on each rupee of H).

It matters because the amount of money with the public affects prices, interest rates, credit and growth. Controlling it is the main job of monetary policy.

Explanation

How money supply is created: the RBI plus the banks

• Two creators work together.
• The RBI creates H, also called reserve money or M0. H is currency plus the deposits banks and others keep with the RBI.

• Commercial banks multiply H through lending. This process is called credit creation.

• How credit creation works (fractional-reserve banking). In fractional-reserve banking, a bank keeps only a part of its deposits as cash and lends out the rest.

• A bank keeps a share of each deposit as reserves. Reserves are vault cash plus the bank's deposits with the RBI.
• It lends the rest. The borrower spends the loan, and the money 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 (CRR = 20%). The Cash Reserve Ratio (CRR) is the share of deposits a bank must keep with the RBI.

• Leela deposits ₹100. The bank keeps ₹20 and lends ₹80. The ₹80 comes back as a deposit, so deposits are now ₹180.
• Required reserve = 20% of 180 = ₹36. The bank can lend ₹64 more.
• The series 100 + 80 + 64 + 51.2 + … has ratio r = 0.8.
• Sum = 100 × 1/(1 − 0.8) = ₹500.
• So money held by the public rises from ₹100 to ₹500.

The money multiplier: simple and fuller formulas

• Simple formula: m = 1/CRR
• CRR 20% → m = 5.

• CRR 25% → m = 4. Maximum deposits fall to ₹400, loans fall from ₹400 to ₹300, and banks must call back ₹100 of loans.

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

• Currency deposit ratio (cdr) = cash held by the public ÷ the public's bank deposits. It shows how much people like to keep cash.
• Reserve deposit ratio (rdr) = the share of deposits banks keep as reserves (required reserves plus any extra they choose to keep).
• Example: cdr = 0.25, rdr = 0.20 → m = 1.25/0.45 ≈ 2.8.
• If cdr = 0 (nobody holds cash), m = 1/rdr. This is the simple formula.

What makes money supply rise or fall

• H rises → money supply rises. H rises when these sources of M0 go up:
• the RBI's net credit to government (the RBI buys government securities or lends to the government);
• the RBI's credit to banks, for example repo loans;

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

• CRR up → multiplier down → money supply down. Banks must keep more with the RBI, so they have less to lend.

• cdr down → multiplier up.
• People keep less cash and more money in banks.

• More money comes back to banks to be lent again.

• Demand for loans. Banks cannot lend if firms and households do not want to borrow. So cheap reserves alone do not raise money supply.

Measures of money supply (RBI)

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; most used ("aggregate monetary resources")
M4	M3 + total Post Office savings deposits (excluding NSC)	Broad (least liquid)

• Liquidity means how easily money can be spent. It falls as you move from M1 to M4.
• Demand deposits (savings and current accounts) can be withdrawn at any time. Time deposits (fixed deposits) are locked for a set period.

In India

• Who measures it. The RBI has compiled monetary statistics since July 1935. It works out M3 by a balance-sheet approach, which combines the balance sheets of the RBI and the banking sector (commercial and co-operative banks) [4].
• Latest figures (2024-25):
• M3 = ₹272.87 lakh crore.
• M0 ≈ ₹48.3 lakh crore. This is currency in circulation ₹37.24 lakh crore + bankers' deposits with RBI ₹9.91 lakh crore + other deposits with RBI ₹1,13,307 crore.

• Money multiplier m = 272.87 ÷ 48.3 ≈ 5.6.

• Check with the fuller formula (2024-25, approximate):

• 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. This is close to 5.6.

• Growth of M3: from ₹11.24 lakh crore (1999-2000) to ₹272.87 lakh crore (2024-25). That is about a 24-fold rise in 25 years.

• Policy tools that affect it:
• CRR was cut to 4.0% of NDTL in December 2024 [5]. It now stands at 3.00% [3]. NDTL (net demand and time liabilities) roughly means a bank's total deposits and similar liabilities to the public.
• At 3%, the simple formula would give m ≈ 33. The real multiplier is only about 5–6, because the public holds a lot of cash and banks keep extra reserves. So the fuller formula describes India better.

• The repo rate (the rate at which the RBI lends to banks for a short time) was cut to 5.50% on 6 June 2025 [2].

• Committee: the Working Group on Money Supply: Analytics and Methodology of Compilation, chaired by Dr Y.V. Reddy, reported in June 1998. It proposed NM1, NM2, NM3 and liquidity aggregates L1, L2, L3 [4].

Don't confuse with

• High-powered money (M0 / reserve money): M0 is the RBI's own liability, the base. Money supply (M1, M3) is built on top of it by bank lending. M3 is about 5.6 times M0 (2024-25).
• Currency in circulation vs currency with the public: currency in circulation includes cash held by banks. Money supply counts only currency with the public.
• Narrow money vs broad money: M1 and M2 are narrow money. M3 and M4 are broad money. Post Office deposits enter M2 and M4, not M1 or M3.
• CRR vs SLR: CRR is kept with the RBI and earns nothing. The Statutory Liquidity Ratio (SLR) is the share of deposits a bank must hold itself in safe assets such as government securities, cash and gold [2]. Changing CRR directly changes the simple multiplier.

Prelims Hooks

• Money supply = m × H. Simple multiplier = 1/CRR. Fuller multiplier m = (1 + cdr)/(cdr + rdr). If cdr falls, m rises.
• Money supply is money held by the public only. It excludes money held by the government and the banking system.
• M3 = M1 + net time deposits of banks = "aggregate monetary resources". It is ₹272.87 lakh crore (2024-25), and m ≈ 5.6.
• "Other deposits with RBI" appear in both M0 and M1. This is a common trap.
• When the RBI buys foreign exchange, reserve money (H) rises, and money supply can rise.
• The Y.V. Reddy Working Group (June 1998) proposed NM1–NM3 and L1–L3 [4]. The RBI has compiled monetary data since July 1935 [4].

Mains Points

• The RBI controls money supply only partly.
• The RBI controls H and the CRR.
• But m also depends on how much cash the public holds (cdr), how much banks want to lend and how much borrowers want to borrow.

• So a CRR cut (4% in December 2024 [5] → 3% [3]) gives banks more money to lend, but credit grows only if people want loans. This is why rate and CRR cuts can reach the economy weakly (GS-III: monetary policy effectiveness).

• Financial inclusion makes monetary policy stronger.

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

• Demonetisation (2016-17) showed the reverse: currency with the public fell sharply.

• Fiscal, external and monetary policy are linked through H.

• When the RBI buys large amounts of government securities or forex (for example, to stop the rupee from rising), H rises automatically, and so does money supply.
• The RBI may then sterilise, meaning it soaks up the extra money through OMO sales, MSS bonds or the SDF so that inflation does not rise.
• Fractional reserves also allow more lending, but they raise the risk of a bank run (many depositors taking out their money at the same time). So they need a lender of last resort and deposit insurance (DICGC).

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
• M1

Read more

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