It will be useful to have an idea of the demand for and the supply of money.
The modern notion about the aspects of money is different from the traditional one. Let us analyze demand for and supply of money separately.
Demand for Money:
The old idea about the demand for money was that money was demanded for completing the business transactions. In other words, the demand for money depended on the volume of trade or transactions. As such the demand for money increased during boom period or when the trade was brisk and it decreased during depression or slackening of trade.
The modern idea about the demand for money was put forward by the late Lord Keynes, the famous English economist, who gave birth to what has been called the Keynesian Economics. According to Keynes, the demand for money, or liquidity preference as he called it, means the demand for money to hold.
Broadly speaking, there are three main motives on account of which money is wanted by the people by the people, viz:
(i) Transactions motive
(ii) Precautionary motive
(iii) Speculative motive
Now a word about each one of them.
(i) Transactions Motive:
This motive can be looked at:
(a) From the point of consumers who want income to meet the household expenditure which may be termed the income motive, and
(b) From the point of view of the businessmen, who require money and want to hold it in order to carry on their business, i.e., the business motive.
(a) Income Motive:
The transactions motive relates to the demand for money or the need for cash for the current transactions of individual and business exchanges. Individuals hold cash in order “to bridge the interval between the receipt of income and its expenditure.” This is called the income Motive’.
Most of the people receive their incomes by the week or the month, while the expenditure goes on day by day. A certain amount of ready money, therefore, is kept in hand to make current payments. This amount will depend upon the size of the individual’s income, the interval at which the income is received and the methods of payments current in the locality.
(b) Business Motive:
The businessmen and the entrepreneurs also have to keep a proportion of their resources in ready cash in order to meet current needs of various kinds. They need money all the time in order to pay for raw materials and transport, to pay wages and salaries and to meet all other current expenses incurred by any business of exchange.
Keynes calls it the ‘Business Motive’ for keeping money. It is clear that the amount of money held, under this business motive, will depend to a very large extent on the turnover (i.e., the volume of trade of the firm in question). The larger the turnover, the larger in general, will be the amount of money needed to cover current expenses.
(ii) Precautionary Motive:
Precautionary motive for holding money refers to the desire of the people to hold cash balances for unforeseen contingencies People hold a certain amount of money to provide tor the risk of unemployment, sickness, accidents and other more uncertain perils. The amount of money held under this motive will depend on the nature of the individual and on the conditions in which he lives.
(iii) Speculative Motive:
The speculative motive relates to the desire to hold one’s resources in liquid form in order to take advantage of market movements regarding the future changes in the rate of interest (or bond-prices). The notion of holding money for speculative motive is a new typically keynesian idea. Money held under the speculative motive serves as a store of value as money held under the precautionary motive does. But it is a store of money meant for a different purpose.
The cash held under this motive is used to make speculative gains by dealing in bonds whose prices fluctuate. If bond prices are expected to rise, which in other words means that the rate of interest is expected to fall, businessmen will buy bonds to sell when the price actually rises.
If however, bond prices are expected to fall, i.e., the rate of interest is expected to rise, businessmen will sell bonds to avoid capital losses. Nothing being certain in this dynamic world, where guesses about the future course of events are made on precarious bases, businessmen keep cash to speculate on the probable further changes in bond prices (or the rate of interest) with a view to making profits.
Given the expectations about the changes in the rate of interest in future, less money will be held under the speculative motive at a higher current or prevailing rate of interest and more money will be held under this motive at a lower current rate of interest.
The reason for this inverse correlation between money held for speculative motive and the prevailing rate of interest is that at a lower rate of interest less is lost by not lending money or investing it, that is by holding on to money; while at a higher rate, holders of cash balances would lose more by not lending or investing.
Thus, the amount of money required to be held under the various motives constitutes the demand for money. It may be borne in mind that, in economic analysis, demand for money is the demand for the existing stock of money which is available to be held. It is stock of money not a flow of it over time.
Supply of Money:
We have described the demand for money as the demand for the stock (not flow) of money to be held. The flow is over a period of time and not at a given moment. In the case of commodity, it is a flow. Goods are being continually produced and disposed of. This is the essential difference between the demand for money and the demand for a commodity.
Similarly, the supply of money conforms to the ‘stock’ concept and not the ‘flow’ concept. Just as the demand for money is the demand for money to hold, similarly, the supply of money means the supply of money to hold. Money must always be held by someone, otherwise it cannot exist. Hence, the supply of money means the sum total of all the forms of money which are held by a community at any given moment.
The stock of money, which constitutes the supply of it, consists of (a) metallic money or coins, (b) currency notes issued by the currency authority of the country whether the Central bank or the government, and (chequable bank deposits. In old times, the coins formed the bulk of money supply of the country. Later, the currency notes eclipsed the metallic currency and now the bank deposits in current account withdraw-able by cheques have overwhelmed all other forms of money.
Thus, money supply means total volume of monetary media of exchange available to the community for use in connection with the economic activity of the country. Broadly speaking, money supply in a country is composed of two main elements, viz., (a) currency with the public; and (b) deposit money with the public.
In order to arrive at the total amount of currency with the public, we add: (i) currency notes in circulation; (ii) circulation of rupee notes and coins; and (iii) circulation of small coins; and from the total deduct- ‘Cash in hand with banks’ The bulk of the currency with the public (over 95 per cent) is in the form of currency notes issued by the Reserve Bank of India. Next in importance are the rupee notes issued by the Government of India.
Besides currency, money supply with the public includes the deposit money, i.e., the bank balances held in current accounts of the banks. In underdeveloped countries, the currency, and not the bank deposits, occupies a dominant position, because in such countries the bulk of commercial dealings are done through cash as a medium of exchange and not through cheques as in advanced countries. Deposit money with the public in India consists of two items, viz., net demand deposits of bank and ‘other deposits’ with the Reserve Bank of India.
By adding total currency with the public and the total demand deposits, we get the total money supply with the public.
It is also worth nothing here that in India the deposit money with the public has now come to exceed, albeit slightly, the total currency money with the public. Compare with it the position in 1950-51, when deposit money with the public was not even one-half of the currency in circulation among the public.
This shows that the banking habit has steadily been growing in the country and the time will not be far off when deposit money will far outstrip the currency money.
The total amount of bank deposits in the country is determined by the monetary policy of the central bank of the country. When the central bank wants to give a boost to the economy of the country, it follows a cheap money policy, lowers the bank rate, which is followed by lower rates of interest charged by the commercial banks, thus helping credit creation by the banks.
There are times, however, when in the interest of economic stability, the central bank follows a policy of credit squeeze by raising the bank rate and purchasing securities through open market operations and adopting other credit control measures.
Thus, the supply of money in a country, by and large, depends on the credit control policies pursued by the banking system of the country.