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Money Supply and Inflation
Money : Anything that performs one of the following functions, is money:
Medium of exchange i.e. all goods and services or physical assets are priced in terms of money and exchanged by using money. A measure of value i.e. money is used to measure and record the value of goods and services A store of value of time i.e. money can be held for any time and can be used in future 4. Standard for deferred payments i.e. ukoney is used as an agreed measure of future receipts and payments in different contracts.
Money supply : It refers to stock of money in circulation in the economy at given point of time. This is decided by the Govt. and by the
Central Monetary Authority (RBI in India). Money stock measures were introduced by RBI during 1970 and the working group
under Y B Reddy suggested major changes in the money stock' measures, which gave its recommendations :during Dec
1997), implemented during June 1998. The current measures are monetary (M) and (L) aggregates.
Money Supply refers to amount of money in circulation. The working group under the chairmanship of Dr. V.V. Reddy, the thbn Deputy
Governor RBI, has suggested four new money measures (Mo, M1, Mz, M3) and three liquidity measures (Li, L2. L3). A ) MONETARY
  • Mo = Currency in Circulation + Bankers Deposits with the RBI + 'Other' Deposits with the RBI;
  • M1 = Currency with the Public + Demand Deposits with the Banking System + 'Other' Deposits with the RBI = Currency with the Public + Current Deposits with the Banking system + Demand Liabilities portion of Savings Deposits with the Banking System + 'Other'
Deposits with the RBI;
  • M2 = M1 4- Time Liabilities portion of Savings Deposits with the Banking System + Certificates of Deposit issued by Banks + Term
Deposits (excluding FCNR (B) deposits) with a contractual maturity up to and including one year with the Banking System; and
  • M3 = M2 + Term Deposits (excluding FCNR (B) Deposits) with a contractual maturity of over one year with the Banking System + Call
borrowings from 'Non-Depository' Financial Corporations by the Banking System.
  • M1 is known as Narrow Money ; M3 is known as Broad Money; Demand Deposits are those deposits which are payable on demand. It includes current deposits, demand liabilities portion of liabilities, etc.
  • M3 + all deposits with the Post Office Savings Banks (excluding National Savings Certificates).
  •  L2 = L1 + Term Deposits with Term Lending Institutions and Refinancing Institutions (Fls) + Term Borrowing by Fls + Certificates of Deposit issued by Fls, and
  • L3 = L2 + Public Deposits of Non-Banking Financial Companies
Sources of money supply
Sources of money supply include net bank credit to the govt., net bank credit to commercial sector, net foreign exchange assets of banking sector, Govt. currency liabilities to the"public,_net non monetary liabilities of RBI and the banks.
Inflation refers to regular increase in the general price level of prices of goods and services, in an economy, over a period of time. Inflation
leads to fall in purchasing power,' because with rise in price of goods and services, the same amount of money, can purchase fewer goods and services. Inflation has positive as well as negative impact on the economy. Inflation helps in bringing an economy out of recession. The negative effect is loss in real value of money.
Demand pull inflation: It is a general increase in prices of goods and services due to increasing aggregate demand for goods and services.
The increasing demand is the result of increased quantity of money in the hands of consumers. 
Demand --> Supply--> Shortage of goods & Services--> Increase in Price
Cost-push inflation: It is caused by substantial increase in the prices of inputs used to produce goods and services. In such cases, the
producers adjust the production. Either they increase the price of the goods produced by them or they produce less that leads to shortage
and inflation.
Measures of inflation
The increase in general price level is measured by a price index. The price index is a weighted average of the prices of selected goods and
services, in comparison to the prices prevailing in the base year.
Inflation = (Price index in the current year – price index in the base year) / price index in the base year x 100

Important price indices include the following:
Wholesale price index (WPI) – This reflects change in the level of prices of goods at the wholesale level. It relates to exchange of goods the level of traders/suppliers and not at the level of consumers. WPI is also known as Headline Inflation. In India, WPI is the official inflation Index.
 Food inflation index : Within the overall WPI, this is a separate index for a group of food and-fuel commodities.
Consumer price index : This index reflects the change in price level of goods and services when these are purchased by the
consumers/households. It measures, the prices at retail level. This is more relevant for the consumer. It is also called core inflation. It is
released by Labour Bureau,Ministry of Labour and Employment, Govt. of India.. The CPI can be different for different groups of consumers
which include consumer price index for agricultural labour (CPI-AL), consumer price index for industrial workers (CPI-.IW)„ consumer price
index for urban non-manual employees (CPI-UNME )and consumer price index for rural labour (CPI-RL).
GDP deflator : It is a measure of the level of prices of all new, Domestically produced, final goods and services in an economy. It is not based on fixed basket of goods and services. The basket changes with consumption and investment pattern. Hence, new expenditure patters show up in the deflator as people respond to changing price.

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