Money Supply and Credit Creation: M0, M1, M2, M3, Money Multiplier, Repo Rate, CRR and SLR for SSC CGL Economics
Rahul Kumar
SSC Exam Expert & Content Editor
In this note
- 1.Functions of Money
- 2.Measures of Money Supply in India
- 3.Money Multiplier and Credit Creation
- 4.Instruments of Monetary Policy of the RBI
- 5.Quantity Theory of Money
- 6.Solved Examples
- 7.Quick Tips
- 8.Quick Revision Points
- 9.Practice Questions With Answers
- 10.How to Practise This Chapter
- 11.Frequently Asked Questions
PDF Notes: Money Supply and Credit Creation: M0, M1, M2, M3, Money Multiplier, Repo Rate, CRR and SLR for SSC CGL Economics
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Money is the lifeblood of an economy, and its supply is controlled by the central bank. SSC CGL Finance and Economics regularly asks about the functions of money, the measures M0 to M4, the money multiplier, the credit creation by banks and the instruments of the RBI. This guide on money supply and credit creation for SSC explains each one with formulas, solved examples and practice questions.
Functions of Money
| Function | Meaning |
|---|---|
| Primary: medium of exchange | Money removes the need for barter |
| Primary: measure (unit) of value | Prices of all goods are expressed in money |
| Secondary: store of value | Money can be saved for the future |
| Secondary: standard of deferred payment | Debts are paid in money |
| Contingent: transfer of value | Money can be moved from place to place |
Measures of Money Supply in India
| Measure | Components |
|---|---|
| M0 (reserve money, high-powered money) | Currency in circulation + bankers’ deposits with the RBI + other deposits with the RBI |
| M1 (narrow money) | Currency with the public + demand deposits with banks + other deposits with the RBI |
| M2 | M1 + savings deposits with post office savings banks |
| M3 (broad money) | M1 + time deposits with banks; the main measure of money supply |
| M4 | M3 + all deposits with the post office (excluding National Savings Certificates) |
- The order of liquidity is M1 > M2 > M3 > M4 (M1 is the most liquid).
- M3 is also called aggregate monetary resources.
- The RBI releases the data on money supply in India; the currency is issued by the RBI (one-rupee notes and coins are issued by the Ministry of Finance).
- Reserve money is called high-powered money because it forms the base for credit creation.
Money Multiplier and Credit Creation
Banks keep only a part of their deposits as reserve and lend the rest, which is then deposited again and lent again, creating more money. The money multiplier shows how much money is created per unit of reserve money.
Money multiplier = 1 / reserve ratio (CRR). In India it is also given as M3 / M0.
Example. If a person deposits 1,000 rupees and the reserve ratio is 10%, the money multiplier is 1/0.10 = 10. The total deposits created can be 10,000 rupees, and the banks have created 9,000 rupees of new credit.
Instruments of Monetary Policy of the RBI
| Instrument | Meaning |
|---|---|
| Cash Reserve Ratio (CRR) | Percentage of net demand and time liabilities that banks must keep as cash with the RBI; no interest is paid |
| Statutory Liquidity Ratio (SLR) | Percentage of deposits that banks must keep with themselves in liquid assets such as cash, gold and government securities |
| Repo rate | The rate at which the RBI lends short-term money to banks against government securities |
| Reverse repo rate | The rate at which the RBI borrows money from banks |
| Marginal Standing Facility (MSF) | Emergency borrowing by banks from the RBI at a rate above the repo rate |
| Bank rate | The rate at which the RBI lends long-term to banks without securities |
| Open Market Operations (OMO) | Buying or selling of government securities by the RBI to control liquidity |
| Standing Deposit Facility (SDF) | The facility to absorb liquidity from banks without collateral |
- To control inflation, the RBI raises the repo rate and the CRR (tight policy).
- To promote growth, the RBI lowers the repo rate and the CRR (easy policy).
- The Monetary Policy Committee (MPC) of six members, formed in 2016, decides the repo rate; the inflation target is 4% with a tolerance band of ±2%.
- Selling securities in OMO reduces the money supply; buying them increases it.
Quantity Theory of Money
- Irving Fisher’s equation of exchange: MV = PT, where M is the money supply, V the velocity of circulation, P the price level and T the volume of transactions.
- According to the quantity theory, the price level is directly proportional to the quantity of money (when V and T are constant).
- Milton Friedman, the monetarist, said that inflation is always a monetary phenomenon.
Solved Examples
Example 1. If the CRR is 5%, find the money multiplier.
1/0.05 = 20.
Example 2. The money supply is 500, the velocity of circulation is 4 and the volume of transactions is 100. Find the price level.
MV = PT, so P = 500 × 4 / 100 = 20.
Example 3. Which rate is the rate at which the RBI lends to commercial banks against government securities?
Repo rate.
Example 4. If M0 is 2,000 crore rupees and the money multiplier is 5, find M3.
2000 × 5 = 10,000 crore rupees.
Quick Tips
- Learn the components of M0 to M4 in order.
- Remember the formula money multiplier = 1/reserve ratio.
- Learn the effect of each RBI instrument on money supply.
- Remember MV = PT.
Quick Revision Points
- M1 is the most liquid; M3 is broad money.
- Money multiplier = 1/CRR = M3/M0.
- Repo rate: RBI lends to banks; reverse repo: RBI borrows.
- CRR is kept with the RBI; SLR is kept with the bank itself.
- Quantity theory: MV = PT.
Practice Questions With Answers
- What is M3 called?
Answer: Broad money - What is high-powered money?
Answer: M0 (reserve money) - If CRR is 10%, find the money multiplier.
Answer: 10 - At what rate does the RBI lend money to banks?
Answer: Repo rate - What is kept with the RBI as cash under CRR?
Answer: A part of net demand and time liabilities - Who gave the equation MV = PT?
Answer: Irving Fisher - Which instrument involves buying and selling of government securities by the RBI?
Answer: Open Market Operations - How many members are there in the MPC?
Answer: Six - What is the inflation target of India (with a band)?
Answer: 4% with ±2% tolerance - Which is the most liquid measure of money supply?
Answer: M1
How to Practise This Chapter
Practise 10 questions every day and write the steps on paper. Then attempt timed sets from our practice papers and the previous year papers page. See all topics on the Finance and Economics notes page, read the previous topic International Trade and Balance of Payments.
Frequently Asked Questions
What are the functions of money?
Medium of exchange, measure of value, store of value and standard of deferred payment.
What is M0?
Reserve money, also called high-powered money, which is the base for the money supply.
What is M3?
Broad money, which includes M1 and time deposits with banks.
What is the money multiplier?
The factor by which the money supply increases for each unit of reserve money; 1/CRR.
What is CRR?
The percentage of deposits that banks must keep in cash with the RBI.
What is SLR?
The percentage of deposits that banks must keep in liquid assets with themselves.
What is the repo rate?
The rate at which the RBI lends to banks against government securities.
What is the reverse repo rate?
The rate at which the RBI borrows from banks.
What does OMO mean?
Open Market Operations: buying or selling of government securities by the RBI.
What is the quantity theory of money?
The theory that the price level changes in proportion to the money supply, expressed as MV = PT.
Who decides the repo rate in India?
The Monetary Policy Committee of the RBI.
Is this topic asked in SSC CGL?
Yes, money supply and RBI instruments are common in Finance and Economics.
Rahul Kumar
SSC Exam Expert & Content Editor
Rahul is a senior SSC exam strategist with 8+ years of experience helping aspirants crack CGL, CHSL and MTS exams. He writes in-depth notification breakdowns, exam pattern guides and preparation strategies.