Before publishing your Articles on this site, please read the following pages: 1. Welcome to EconomicsDiscussion.net! In the present times currency is inconvertible. Some economists therefore call it ‘The H Theory of Money Supply’. OD = Other deposits held by the public with Reserve Bank of India. However, these other deposits of Reserve Bank of India include the following items: (i) Deposits of Institutions such as UTI, IDBI, IFCI, NABARD etc. Therefore, there has been a decline in RBI’s credit to the Government in the last about 10 years. We explain the sterilization operations by RBI later. Disclaimer Copyright, Share Your Knowledge The Government also borrows from the ordinary commercial banks. We have seen above, Money Market Equilibrium in an Economy (With Problems). The Federal Reserve in â¦ But RBI has neutralized its monetary impact by mopping up liquidity of the banks through open market operations by selling them Government securities. Thus. Concept of Money Supply and Its Measurement: Factors Determining Money Supply: RBPS Analysis. Through cheques these deposits can be transferred to others for making payments from whom goods and services have been purchased. Now, an important question is what determines the size of money multiplier. Thus, a decrease in the cr raises the money multiplier and the money supply. The figure shows the average money holdings of a family that earns a three thousand dollar paycheck per month. 60,000 crore in 2004-05. But it has to be kept strictly within safe limits. Since the two require different types of policy measure by the Central Bank, they clash with each other. On the other hand, internal balance exists when the economy is in equilibrium at full employment or full productive capacity level without any inflationary pressures. As a result of Central Bank intervention to meet the current account deficit and to maintain the exchange rate money supply in the economy decreases. If instead currency reserves held by the banks increase, this will not change the money supply immediately but will set in motion a process of multiple creation of demand deposits of the public in the banks. TOS4. But when the Central Bank (RBI in case of India) pays out foreign exchange from its reserves, it will receive money (i.e., rupees in India) from importers of goods and services in return for foreign exchange paid to them to meet the deficit. The success of monetary policy critically depends on the controllability the monetary authority has over money supply. RBI is not bound to convert notes into equal value of gold or silver. 48 per US dollar, EH is the increase in capital inflows. 72 and keep Rs. In this way more rupee currency (i.e., high-powered money) comes into existence in the economy. In other developed countries, since 1957 Reserve Bank of India follows Minimum Reserve System of issuing currency. But these Rs. According to monetary economists the single most important factor that determines money supply is (H). and determination of money supply with a view to restraining the tendency mentioned above. We explain below the role of these two factors in the determination of money supply in the economy: The high-powered money which we denote by H consists of the currency (notes and coins) issued by the Government and the Reserve Bank of India. – Explained. However, it is more popularly called âMoney-multiplier Theory of Money Supplyâ because it explains the determination of money supply as a certain multiple of the high- powered money. It was previously called deficit financing. Opposite result would follow when there is a net surplus in the balance of payments of a country. In this way inflationary pressures created by the original increase in money supply through intervention in foreign exchange market have been offset. The sterilization measures can be used both to offset the reduction in money supply when in case of current account deficit the Central Bank of the country sells foreign exchange in the market and also when the Central Bank offsets the effect of increase in money supply when it buys foreign exchange from the market in case of surplus in balance of payments or when large capital inflows are coming into the economy. Besides, in the open economy there are flows of capital between countries. We have seen above how a small increase in reserves of currency with the banks leads to a multiple expansion in demand deposits by the banks through the process of deposit multiplier and thus causes growth of money supply in the economy. In economic analysis it is generally presumed that money supply is determined by the policy of Central Bank of a country and the Government. firstname.lastname@example.org +234 813 292 6373. 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