Question

In the measurement of money supply aggregates, which of the following components is explicitly included in the definition of the \( M_1 \) money aggregate?

• A. \( \text{Currency held by the public} + \text{Demand deposits with commercial banks} + \text{'Other' deposits with the RBI} \)
• B. \( \text{Currency held by the public} + \text{Total post office savings bank deposits} \)
• C. \( \text{Demand deposits with commercial banks} + \text{Net time deposits with the banking system} \)
• D. \( \text{Total deposits held by all non-banking financial companies (NBFCs)} \)

Hint:

\( M_1 \) is the most highly liquid measure of money supply, while \( M_4 \) is the least liquid. In terms of overall usage volume across the economy, \( M_3 \) is the aggregate most commonly referred to as "Broad Money."

Answer 1

The Correct Option is A

Step 1: Understanding the Concept:
The Reserve Bank of India (RBI) uses four alternative measures of money supply (\(M_1, M_2, M_3, M_4\)).
These measures are ordered by liquidity. \(M_1\) is the most liquid and is known as "Narrow Money."
It includes assets that can be immediately used for transactions.
Step 2: Key Formula or Approach:
The mathematical definition of \(M_1\) is:
\[ M_1 = C + DD + OD \]
Where:
\(C\) = Currency (notes + coins) held by the public.
\(DD\) = Net demand deposits with commercial banks.
\(OD\) = 'Other' deposits with the RBI.
Detailed Explanation:
Let's break down why Option (A) is the only correct answer:
1. Currency (C): This is the cash in the hands of the people. It is the most direct form of money.
2. Demand Deposits (DD): These are funds in current and savings accounts. They are called "demand" deposits because banks must pay them back whenever the customer "demands" them (e.g., via check or ATM).
3. 'Other' Deposits (OD): These include deposits of foreign central banks, international financial institutions (like IMF/World Bank), and quasi-government bodies with the RBI.
Analysis of Incorrect Options:
- Option (B) describes part of \(M_2\) (which is \(M_1\) + Post Office Savings).
- Option (C) mentions "Time Deposits" (Fixed Deposits). Since money in an FD is locked for a period, it is not "on-demand" liquid and thus belongs to \(M_3\) (Broad Money).
- Option (D) involves NBFCs, which are typically excluded from the standard RBI money supply aggregates for banking liquidity.
Step 3: Final Answer:
The core components of \(M_1\) are Currency, Demand Deposits, and Other Deposits with the RBI.
This is exactly what Option (A) states.