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Tuesday, November 22, 2016

Impact of Demonetisation


The government's move to demonetise `500 and `1,000 currency notes will immediately impact reserve money and money supply in the system along with the balance sheet of the Reserve Bank of India, the sole authority in the country for accepting currency notes and coins as legal tender. ET explains the interplay of currency, reserve money and money supply.

1. What is currency in circulation?

It is the total value of currency (coins and paper currency) that has ever been issued by the central bank minus the amount that has been withdrawn by it.

Currency in circulation comprises currency notes and coins with the public and cash in hand with banks. It is a major liability component of a central bank's balance sheet.

2. What is reserve money?

It is essentially the central bank's money . It is also called high-powered money , base money and central bank money . As per the definition, reserve money equals currency in circulation plus bankers' deposits with RBI plus `other' deposits with RBI. It is the base level for money supply or the high-powered compo nent of money supply .

3. What is money supply?

It is called broad money, too, as it also includes deposits generated in the banking system resulting from a multiplier effect of movement of currency in the banking system as well as other forms of liquid assets. Thus it is the total stock of money circulating in an economy .

4. How does demonetisation affect reserve money and money supply?

When a currency note of a particular denomination ceases to be legal tender, the central bank's liabilities are reduced to that extent and also the amount of currency in circulation declines. But the demonetisation impact is neutralised when the demonetised currency is replaced with new accepted currency notes. In the current context, though, if an individual chooses to park the cash as deposits with banks, then it forms a part of the overall money supply .

5. How will it affect the RBI's balance sheet?

If people choose not to declare and surrender their high-denomination currency notes, then RBI stands to gain to the extent that its currency liabilities are lowered. The gains it makes in the process are transferred to its reserves and then appropriated in its profit and loss account. This gives it leeway to transfer higher amounts as dividends to the government





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