Types of Money and Measures of Money Supply: Banking Awareness Special Series

Team Adda247 and Bankers Adda have introduced a Special Banking Awareness series for SBI and IBPS Interviews 2021. In this series, we will be introducing the candidates with some banking awareness topics Daily that will improve their general awareness and will also ensure that the candidates do not lack in any banking term when it comes to the interview round. Today the topic of our Banking Awareness Series is Types of Money and Measures of Money Supply.

Types of Money and Measures of Money Supply

A.) Types of Money: There are majorly four types of Money accepted widely as follows:

1.) Fiat Money: It is a legal tender that is declared by Government and it is accepted by all people and companies or any other institutions within the country for payment transactions. Fiat money is not backed by physical commodities. It is just a value that is derived between the relationships of supply and demand. Its intrinsic value is significantly lower than its face value. Examples of Fiat Money are Coins and Bills.

2.) Commodity Money: Commodity money is the oldest type of money. It has been considered as a medium of exchange, a unit of account, and a store of value. It is related and originated from the ‘barter system’ where people fulfill their requirements by giving goods or services as payment. The commodity itself is valued as money. Examples of commodity money are Gold, coins, spices, wheat or food grains, etc.

3.) Fiduciary Money: Fiduciary Money value depends on the confidence that it is generally accepted as a medium of exchange. It is not declared by legal tender by the government thus people do not abide to accept it as means of payment. If people are confident that the promise will not be broken, they could use it as a regular fiat or commodity money. Examples are Cheques, Banknotes, and Drafts, etc.

4.) Commercial Bank Money: It is debt-generated money of commercial banks that can be exchanged for money or to buy goods or services. Commercial bank money is generated through fractional-reserve banking, in banking practice, banks keep only a fraction of their deposits in reserve and lending out the remainder, while maintaining the concurrent accountability to redeem all these deposits upon demand. 

4. Measures of Money: There four measures for money supply are as follows: M1, M2, M3, and M4. It is classified by the Reserve Bank of India (RBI) in April 1977 before this classification the RBI published only one measure of the money supply which is M.

 M1: It is the first measure of the money supply known as narrow money.

Coins and notes of all denominations which are in circulation within the public are called M1 money. 

Demand Deposits in the commercial banks and co-operative banks are also considered in this measurement; excluding inter-bank deposits.

Current deposits of foreign central banks, financial institutions are also considered in this measurement of money. 

M2: This second measure of money supply consists of M1+ post office savings bank deposits.

In the money supply savings deposits of commercial and cooperative banks are already included it is necessary to include post offices savings bank deposits. The post office deposits have been given more preference than bank deposits in the majority of people from rural and urban areas from a safety point of view. 

M3: This third measure consists of M1+ Commercial and cooperative banks’ time deposits. It excludes interbank time deposits. It is known as ‘broad money by the Reserve Bank of India. 

M4: The fourth measure of money supply consists of M3+ all post office deposits including time deposits and demand deposits. 

M3 includes total deposits of banks and currency with the public in circulation thus RBI prefers it most in credit budgeting for its credit policy. Even it is also taken into account in formulating macroeconomic objectives of the economy every year.