Brief notes on four broad approaches of money supply

Economists are not in agreement on the question of definition of money supply. There are four broad approaches of money supply. They are as follows:

1. Traditional Approach:

The traditional approach emphasises the medium of exchange function of money. According to this approach, money supply is defined as currency with public and demand deposits with commercial banks. Demand deposits are the current accounts of depositors in a commercial bank.

The traditional approach is analytically superior because it provides the most liquid and exact measure of money supply.

The central bank can have better control over the money supply if it includes currency and demand deposits of banks alone. But, this approach limits money supply to a very narrow area.

2. Monetarist Approach:

The Chicago School led by Milton Friedman includes in money supply currency plus demand deposits plus time deposits. Time deposits are fixed deposits of the banks which earn a fixed rate of interest depending upon the period for which the amount is deposited.

According to Friedman money is defined as “anything that serves the function of providing a temporary abode of purchasing power.”

Money can act as a temporary abode of purchasing power if it is kept in the form of cash, demand deposits or any other asset which is close to currency, i.e., time deposits. This approach lays emphasis on the store of value function of money and provides a broader measure of money.

3. Gurley and Shaw Approach:

Gurley and Shaw further widened the scope of money supply by including in its constituents currency plus demand and time deposits of banks plus the liabilities of non-banking intermediaries. The liabilities of non-banking intermediaries cover saving bank deposits, shares, bonds, etc. and are close substitutes to money.

4. Radcliffe Committee Approach:

Radcliffe Committee approach or liquidity approach provides much wider view of the concept of money supply. In this approach, the concept of money supply is viewed in terms of general liquidity of the economy.

Money supply covers “the whole liquidity position that is relevant to spending decisions.” The spending is not limited to the amount of money in existence. It is related to the amount of money people think they can get hold of whether by receipts of income, by disposal of assets or by borrowing.

Thus, according to this approach, money supply includes cash, all kinds of bank deposits, deposits with other institutions, near-money assets and the borrowing facilities available to the people.

The practical difficulty with this liquidity approach is that the money supply in this wider sense cannot be successfully measured because the degree of liquidity of different constituents of money supply varies considerably.

Moreover, most of the constituents remain outside the control of central bank and thus restrict the effective implementation of monetary policy.