How Money in the Bank constitute the total money supply of the economy?

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The demand deposits held by the public in commercial banks also constitute the total money supply of the economy. The demand deposits are transferable by cheque for the settlement of debts. The creation of bank money depends upon the credit creation activities of the banks.

Credit creation is based on the volume of cash, i.e., the high-powered money, held by the banks. The money created by the banks is known as secondary money. Thus, the total money supply in an economy is composed of (a) the primary or high-powered money, and (b) the secondary or bank money.

The relative proportions of the two constituents of money supply, i.e., currency money and bank money, depend upon the degree of monetisation of the economy, the development of the banking system and the banking habits of the people.

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In the economically advanced countries, like the U.S.A., the U.K., etc., chequable demand deposits constitute the major proportion of the total money supply. In such countries, over 90 per cent, of the payments are made through cheques.

In less-development countries, like India, on the contrary, the proportion of currency money to the total m Ley supply with the public is much higher.

It is because in these countries, banking habits of the people have not yet fully developed and majority of the transactions are conducted through cash payments. In India, currency constitutes about 2/3rd of the total money supply, while the demand deposits are only 1/3rd.

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