What is reserve money? Why it is important in monetary policy?

There are different forms of money supply – reserve money, narrow money, broad money etc. But the most important indicator of all these is reserve money. It is also called as high powered money, base money and central bank money. All these name suggests that reserve money represents the base level for money supply or it is the high powered component of money supply.

Other forms of money like broad money depends upon the volume of reserve money. Actually, broad money will be a multiple of reserve money.

To understand reserve money, we have to look into the components of it.

Reserve money =

Currency in Circulation + Bankers’ Deposits with RBI + ‘Other’ Deposits with RBI

Among these components, the most important one is currency in circulation. It includes notes in circulation, rupee coins and small coins.

"Currency in circulation’ includes notes in circulation, rupee coins and small coins. Rupee coins and small coins in the balance sheet of the Reserve Bank of India include ten-rupee coins issued since October 1969, two rupee-coins issued since November 1982 and five-rupee coins issued since November 1985. Currency with the public is arrived at after deducting cash with banks from total currency in circulation, as reported by RBI."

The other two components are small in size. To understand the relative importance of the three components, look into the data shown in the coming part.

Bankers’ Deposits with the RBI represent balances maintained by banks in the current account with the Reserve Bank mainly for maintaining Cash Reserve Ratio (CRR) and as working funds for clearing adjustments.

Other Deposits with the Reserve Bank for the purpose of monetary compilation includes deposits from foreign central banks, multilateral institutions, financial institutions etc.

Reserve money in India

Following is the size of the three components of reserve money as on end January 2016.

Total Reserve money is Rs 2005370 crores.

  • Currency in circulation Rs 1584000crores,
  • Banker’s deposit with the RBI Rs 408100 crores
  • Other deposits with the banking system is Rs 13350 crores

Reserve money holds the topmost position in the RBI’s monetary policy. Since it is mostly currency in circulation with the people, reserve money decides the level of liquidity and price level in the economy. Management of reserve money is thus very important to manage liquidity and price level (inflation).