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    Money & Banking

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    Justin D'souza

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    © All Rights Reserved
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    Meaning and Evolution of Money FormsofMeney Supply of Money — Concept of Money Supply and Measurement of Money Supply Example: A rupee in Indias money, ast is a commonly accepted medium of exchange here. Likewise, a dollar in USA Is money, as it is a commonly accepted medium of exchange thee Inolden days, There was na money. Thus 2 cobbler would make shoes in ceturn fr wheat from the farmer; afar worker would get grains asa reward for his labour, and soon, This system of exchange was known as But with the muliplciy of wants (and greater need for exchange), barter system {a.sjster where goods were exchanged for goods) proved to be an Inefficient system of exchange. Its then that we invented money—a fommon medium of exchange. Now goods were not sold for goods Instead, goods were sold for money Ialy, coins of gold and siver were introduced as money. Subsequently, was used for coinage, along with Maney. And, now isthe age of {inthe form of cash fad), o° emoney in the form of ‘electronic transfer of money’ by May of credit/debit entries inthe bank accounts. Thus, the oxigin (and {solution of money is elated to the need to facitate exchange. Drigin and evolution) of maney i eat tothe nee to focitate © Tenet a ‘enero defined as 9 ha thats commonly accepted aca medium cfexchonge 133 134 ‘Though initially invented as a medium of exchange, gradually money. found its other uses as well: 1m Money is used as a store of value, Or, money is used as an Instrument of saving. 1m Money is used as a measure of value. Value of goods and services is expressed in terms of money. 1m Money is used as a standard for deferred payments (deferred payments are those payments which are made sometimes in the future). ‘Owing to its multiple functions, money has acquired a wider definition than merely a medium of exchange. ttis defined as an instrument that serves as a medium of exchange, store of value, measure of value and, standard for deferced payments. Briefly, itis sald that ‘money is what money does. store of value @ measure of vale and 2 standard for deferred payments Basic Functions of Money The defintion of money conveys the baie unctions of ane). These are) Money acts ae a medi ‘of exchange, (i) Money serves 2s a store of vale (ouope save in terms of money) (i) Money ‘measure of valve market price of goed and services expvassacin terms of money and) Mon Serves as standard for deferred bayments future payments) when business cantrects ae ‘on the basis of future payments, mane acts 8. natement fo those payments. Barter System of Exchange Barter system of exchange isa system in which goods are exch for goods. If (asa farmer) you have surplus production of rce, you to look for a person who needs rice, and at the same time has ( cloth, which you need for yourself. It means ‘double coincidence: wants’: your want for cloth must coincide with somebody's want Flee, and you must have surplus of rice and somebody must have. surplus of cloth, How difficult i is! What do you co these days? a farmer, you sell rice for money, and as a cloth merchant, you your cloth for money. With money in hand, you buy whatever Wish to buy. Thus, rice is exchanged for money, doth is exchan for money. Money acts as a common medium of exchange. No ‘common medium of exchange exists in the C-C economy (commodi for commodity exchange economy) where goods are exchanged goods. ©-C Economy © stands for commodity. C-C economy is the one In which commodities are exchanged for ‘Sommodies ern utich goods are exchanged fer ods C-C exchange afro art! System of ‘Exchange. Hence, C-C econemy isan enemy dominated by Barter System of Exchange Drawbacks of the Barter System and their Elimination Following are the principal drawbacks of barter system of exchange. itis with the introduction of money that these drawbacks have been, eliminated (1) Double Coincidence of Wants: Double coincidence of wants is a core characteristic of the barter system of exchange. Double coincidence of wants implies that (at a point of time), the two indviduals are in possession of such goods which they are wiling to exchange forte satisfaction oftheir wants. But it not Always 50 simple. 1 isnot so simple to find a person who wants your horse and at the same time has a cow that you want to buy. Accordingly, under the barter system, exchange remained extremely limited. With the emergence of money (as a medium ‘of exchange), the problem of double coincidence of wants has vanished. Money as a medium of exchange has separated the acts of sale and purchase. (@) Lack of a Common Unit of Value: What i the value of your car? You can reply © 5 lakh, Can you give the same answer in a barter syste of exchange? Certainly not. Under such a system, your car would be valued in terms of horses, cows or butfales, simply because there is no money (or a common unt of value). Evolution of money has given us @ common unit of value and therefore, a system of accounting {G) Difcuty of Future Payments or Contractual Payments: These days you hire a worker and strike a contract to pay him (say) © 10,000 p.m. What do you do ina barter system? Would you decide to pay him in terms of tables or chars, in terms of rice or wheat, in terms of drugs or chocolates? Contractual payments oF future payments would certainly be very dificult under barter system of exchange. Evolution of money has facilitated contractual payments. {4) Diticulty of Storage of Value (Saving) and Transfer of Value: In | the GC economy, saving is possible only by way of storage of 00d. t involves substantial storage cost as well as the fear of Capital loss (owing to natural disasters). Further, what happens if you are to transfer your saving from one place to the other? overs eto the eens of ‘ichance le Expansonot srchunce hase toapareonot the Imatetster goods and are le Exoansin of maket hasied oexpsnson cfthessleet caput le Exoanson of ho fonsy 135 a fer the goods. Which again is a ‘pensive. Evolution of money has re much easier ¥ Obviously, you are to transf dificult task, besides being ex tend storage and taster of va MEHOTS {Introduction of money ‘ans. Under the barter system of exchange ‘Sine pono time, To buy thing, an Sire erson. Also, sale and purchase by an kil must vith he introduction of money (as amedium of xchange) Hie ting anything atthe sae time. tee be can sol 2 witht tn me ce. Tus, wth he notuction of mane 2 of ben separated lf and purchase How? eat sale and purchase ofa india must occur a he at al must tthe same time selzometing needed bY he be of equal value. anindhidualcanbuy thing with moe or money without baying je aid purchase have has separated the acts of 3 2. FORMS OF MONEY ‘some important forms of money are d (i) Fiat money and fiduciary money, and (i Full bodied money and edit money. jeseribed as under: () Fiat Money and Fiduciary Money Fiat money eefers to that money wich issued by orer/ authori the goverament includes ll notes and eons which the people aunty are legaly bound to accept as a medium of exchange Frducary money is that money which is accepted as 2 medi rvange because of the trust between the payer end the ft aample Cheques are fiduciary money as these ae accenio east payment on the basis of trust, nt onthe basis of any ‘of the government. (i Full Bodied Money and Credit Money Full bodied money refers to money in terms of coins whose cor ares equal to the money valle as and when these a¥e Example: A rupee coin during the Bish period in India was re silver. Commodity value of the ‘he time offs issuing. Cr, the market value of the siver conta the coin was equal to% 1 ‘Credit roney refers to that money of wich mney value mg crear aity valve. Example: What isthe market value of the Commodity Value fom 3. SUPPLY OF MONEY Supply of money isa stock concept. It refers to total stock of money (of all types) held by the people of a country ata point of time. It is important to note that the supply of money does not include’ {i) stock of money held by the government, and (ji) stock of money held by the banking system of a country. Because, government and the banking system of a country are suppliers of money, and the stock fof money held by the suppliers of money is never treated as a part of the supply of money in the country Tip fen ee Bet ry hw ape em ECS ppt orca hms ord opp of ote festa ck of Iu wh el ore demand mony x oh ip mae. TONE GHOTS TE) Who are the producers of money? ‘hos. Producers of money refer to supplier of money. They inci: i) the government ofthe country, and (i the banking syste of a country, including both the central bank (whieh isthe ete issuing authority) and the commercial banks {who edd to the supply of money throvgh demand epost 137 Measures of Money Supply In nia, there are four alternative measures of money supply, popularly known as M,, Ml, My, and My. Ofthese, only M, measures discussed here, as prescribed in the syllabus. M, M3 and My measures are given In ‘Ability Zone’ of the chapter for general reference IM, Measure of Money Supply ‘According to M, measurement, money supply incl.des the following. components M,=¢+DD +00 Here, : It refers to currency held by the public It includes coins as wall as paper notes DD: It refers to demand deposits ofthe people with the commer banks. These are chequeable deposits which can be withdraw or transferred on demand. (OD: These are other deposits which include: () Demand deposits with RBI of public financial institutions fi INABARD (National Bankefor Agriculture and Rural Development (i) Demand deposits with RBI of foreign central banks and of th foreign governments. (ii) Demand deposits of international financial institutions like l and World Bank Specifically, OD does not include: ( deposits of the government of the country with RBI, (i) deposits ofthe countrys banking system with RBI [Net Demand Deposits and Gross Demand Deposits Distinction may be chawn between gross demand deposits and net demand deposits ccommarcial banks Grass demand depos include intr-banking claims: clsimscfone bank: the athe. Net demand depots donot include inter banking cls nte-bankieg cls part of demand deposits ofthe pecete. [Note of Caution ‘Only nat demand deposts are taken as apart of money Sup 138 ‘Term Deposits and Demand Deposits, Term deposits referent fom demand deposits {Term deposit are abs for @ specific perio of tne: ike fred daposts fora peed of ane arora years Demand daposts are rot for any specfic period of time fi) Deposters cannot withdraw mane (nixed deposts)asand wien needed. Money.ndemond epost can be withdkann a anduhen needed. (i) Term deposits are not chequeable deposits. Depostors cannot sgn a cheque against these epost, Demand cspoets ae ohequeable deposi. These ae (a) saving acooure deposi fre fb eurent account depeets, Depostrs can signa cheque and witidraw/ranfar money Trem these accounts Note of Caution inthe context of My measurement of maney suppl. nly demand depos are consiceres as a part ‘of money supply. NOT the tam deponts [Demand Depasts = Saving Account Deposts + Curent ‘aeoount Deposits), Measure of Money Supply (M) ‘cutency with (Demand Depasits of the People ‘other Depa the Public ‘withthe Commercial Banks wth ReserveBank (W) Demand Deposts cfinternatonal France nsttutions (ike nt and Wari Bona Demand Deposts (i) Demand Deposits with Reserve Banke with Reserve Banko of Public Fnancal Foreign Central Banks MansiiKeNABARD) ] stl Govaerts [Note The ser practice to conde) Caren wth the pubic ad (Demand depots othe people ‘th the comer bare athe ta pnp components of mene supp} nthe enor Who Supplies Money? Suppliers of money include: (}) central bank of the country (RBI in India), (i) commercial banks, and (ii) the government. India, Re isthe principal supplier of money. RB issues currency on the bas of Minimum Reserve System. Under this system, Reserve Bank Maintains @ minimum reserve of € 200 croc inthe form of gold and foreign securities. OF thisreserve, value ofthe gold must be @ 115 coe. ‘Commercial banks are the second significant source of money supply “Unlike the central bank, commercial banks do not have the authority “of issuing currency. The commercial banks cannot Issue notes and “coin. Yet, they are the suppliers of money as they create money by “way of demand deposits. These deposits serve as supply of money “because these are chequeable deposits. People can withdraw or Atansfer money by wring cheques. Money created bythe commercial Banks by way of demand deposits is called Bank Money. Morey 139 third source of money supply in the county: Ht Government is the spee notes and coins of all Thala, the Ministry of Finance sues one 1 denomination ‘Bank Money and High Powered Money Bank 2 amare eater banks ee eter teamed ee Ml we rep na ioh power parks and () cash resus of (Pe rene Pe banks wth the RB: Ths i oa oe or Base Money tthe 200M, arene ancy aby pecee SOT Tony ie ere acronis wi 819 1 Ta So pclae nee tae as expo yutcanoftbe commer te spay heey Pe, OK enor sh Me state he pncipl components of mane” EB oo Fe rina components of money SUPP 6 I curenoy notes cis ely the pub 1 and depos oth pon wth he come banks, and A Cxerdopsts(eand epost wth of Soe nd foreign inaiutions other thal seeoverment ofthe county and commer) ranks within the count ‘2 why are cash epost ofthe government rahe comarca banks wih she RBL Po este pat of money upp? ‘ann ecnse government and commer ‘re ereators/supplers of money is never Power Points & Revision Window axa medium of evchange 1 hasbeen (vets cranes ae cestosuppber of mone. Ard Tone Ml oa da par cf mone SUPPN- sow is avrg whi i cormmoniy accent 1s ane eices of barter system of xch=TES anoxia snes Heh MG ‘exchanges for commosites Th \ ithe se moa fr cammouty charg xonany oF 6% orowbacs () neequrs double condecect warsseh hard to fin, {ih tlacis a common untof hand. ogee ster payments cf dferse TEN Why tea he stem of tra ana nse of ale sidocey money's tht mney which scented 62 ll ‘of exchange because a ast between the payer and the pave tt died Money: Money vahe=commosty vals oF TOT crn oma Money lu of nea ates” COmMOSY WS pf coins and nates jak Ma is 9 stocker a aoschmone asl ne pw PaHe Poy | rock of Money wth the government and Te ening ster ofthe county not consi conn \ M riar money is that maney which ssved ‘ceder (authority) of the government port of money supp Fo apc wth PIC® Damiana DEPOSED commercial Banks ‘Seposts wn the Reserve Bak. 0 sodurory Macoecnories EXERCISE 1. Objective Type Questions (Remembering & Understanding based Questions) A. Multiple Choice Questions choose the corect option: 4. Barter sytem refers to that system wherein (a) goods are exchanged for foods (6) gacds are not exchanged a all (c} goods are exchanged for domestic cureney (8) goods are exchanged fr foreign currency 2. Which ofthe folowing is typical characteristic ofthe barter system? |e) Acommon medium ofexchange [b) Double coincidence of wants {6} common unitaf account [a Astandard for deferred payments 3, Which of the fllowing is commonly accepted definition of money? (a) Any good which is commoniy used a a store of value (b) Any goad which is exchanged for gold a fied rate {@) Any good which is acceptabe to bank {@) Any eood which s commonly accepted as a medium of exchange 4, Maney whichis accepted as a medium of exchange because ofthe trust between the payer andthe payee ealed (a) fullbadied money (by creat money fe) Rat money (d) fiduciary money 5. Full bodied money is that money whose money value and commocity value are {a} equalin the market () declared 2s equal by the government (@)aiferent nthe market {4) declared as equal bythe RBI 6, Money that issued bythe authority of the government i called (9) tll bodied money [b) creet money (c) fist money [a fiduciary money 7. when money value af money exceeds commodity value of mone, tis calle: {a} ful bodies money (b) credit money (2) fat money (4) fiduciary money 5. Money as a standard for deferred payments has led tothe emergence of (3) commodity market (0) financial market {c) both (a) and fo) (a) none ofthese 9. Which ofthe followingisthe component of Mt, measure of money supp”? (6) Term ceposie {b) Demand deposits (6) Cosh reserves ofthe commercial banks (d} None ofthese : 1D. Bank money is that money which is (a) printed by RBI (b> printed by the government 7 |e) generated inthe farm of credit creation (2) none ofthese Woney 1441 — 41, Who supplies money in ina? {a} The Ral {b) The commercial banks [eq Thegovernment 12, Demand deposit neude {ar chequeable deposits {e) fired deposits fora per 13, inl, there are four alternative measures of {G) cortency wth people {by currency with peosle + Demand depos tc) currency wth people + Demand deposits +Other {) None ofthese 14, Supply of money i53 (a) flow variable (by stockvatable (e) reatfow {a} none ofthese (a) Allofthese (oy depots which canbe withdrawn on demand (a) both (ab ane (O) money supp: Ma od of time My yan My ofthese My= deposits with the Reserve Bank 15. In\nda, coins are sued by (a) State Banko nia (b) Reserve Banko nda [e) Ministry of Finance {@) Minery of Urban Development 16, introduction of money ha {Gr separated the acts of sale and pt {b) combined the acts of sale and purchase ofa {@) expanded the sope of ale and purchase (a) both a) and) 17, Which ofthe fallowing systems is followed {a} Proportions stom {@) Minimum reserve system 48, High powered money s eau 0: fa) money supplied bythe ABI only {by total supply of money the economy {c) notes and coins helaby the people {@) money tnoes and cis) nes the opt vA cash aoe irate commercial banks with the RBI scchase ofan individuah niu by Reserve Bank fino forieulng cure? {Oy simple deposit system [a Fsed ducar sue syste ofthe commercial banks 2s well a answers ai 2) 38) 9.0) 30.14 a 21) 3. 240) aa sy 6 7D) BE asi 260) Tl 288) 8. Fillin the Blanks “choose appropriate word and filin the lank: rvs commonly accepted asa medium of exchange scale 4. Athina wh (coramodiy 18 or goods isknown 35 Ibarter system of exchange/monets 57 2, spor wire goods are exchange emaf 142 23, Evcluton of money has faclitates {current payments/contactual payments) 4, Main charactersae of money i (iquiiyslidnes) 5. ‘value of paper notes what writen oa (tMoney/Cemmediy) 6 rmaney is accepted as a medium of exchange because of the trust between the payer and the pave. (FiauFidueary 7. Under the barter system of exchange, acts of sale and purchase of an Individual oesur at the point () of ime (semelcitferent), 8 refers to total stock of money held by the people ofa country ata point of ume. {Supoly of monevOemand fx money) Answers 1. money 2 barter system of exchange 3. contractual payments 4 liquidity 5. Money G.Fiduciry ——7.same 2. Supply of money ¢.True or False State whether the following statements are True or False: 1. €-Ceconamy isan econemy daminted by barter sytem af exchange, (iruefratse) 2. Inbarter system deferred payments are made inthe form of goods (ruefalse) 2, Incase of credit money, money values ess than commodity value. (rue/False) 4, Expansion of exchange has le to expansion of the markets for goods and services. (rue/Flse) 5, Flat money includes all notes and cheques which the people inacountry are legally bound to accep as a medium of exchange (ruerFalse) 6. Supply of money includes stock f money held bythe goverment (ruerFalse) 7. Commercial tanks ad to the supply of money through demand depos. (ruerFate) 8. Only net demand depos are taken asa part of money supply. (veal) Answers A twe 2.True a.fale 4 Tue S.falie 6.Fake 7.True &.True B) BiMatching the Correct Statements I. From the set of statements given in Column and Column Il, choose the corect palr of statements: ‘olumnt olan (2) Fullbodies money (Money alue> Commodity ale of noney (b) Tem deporte (i) chequeable epost | (eater stem of echange (i) Goods are xchange for money (6) Gross demand epost (Doesnt nude ntarbanling as |e) eh ponered money {v} Base mane Inthe econo (e} High powered money—|9) Base moneyn the economy Morey 148 Identity the correct sequence of alternatives given in Column It by matching them with respective items in Column Giant Canna {@) Goverment of country (0 Legaltenders (6) suppy of money (i Cheoues (cu Li Sopp of money (a) Féuciay money (i Principal supple of morey (e) Notes ad sine (0 Astockeoneept Answers (2), (0-0, (9, (@)=(i, (2-0) E. ‘Very Short Answer’ Objective Type Questions 1 What is barter system of exchange? Ans. Barter system of exchanges 2 system in which goods are exchange for goods. Money as a med of exchange doesnot exis 2. Define C- economy. ‘Ans. CC economy refers to that economy in which commodities are exchanged for commodities ori hich goods are exhanged for goad. 3. What do you mean by double coincidence of wants? [Ans. Double coincidence of wants means that goods in possession of two diferent ndividuals are byeach other atthe same ime 4. What ie meant by money? ‘Ans. Money canbe defined as something thetic generally accepted ara medium of exchange and acta measure and estore of value. 5. What is fat money? [Ans Fiat money refers to money backed with order (authority) af he government 6. What is fiduciary money? ‘Ans. Fiduciary money s the money backed with mutual ust between the payer andthe payee 7. Define full bodied money. ‘Ans. Full bodied money refers to mney in terms of coins whose commodity values equal tothe mo Value a and wien these ar sued 8. Whats erat money? [Ans Credit moneys the money of which money value (face values mare than commodity value iz value 9. Whats bank money? |Ans. Bank money isthe money create by the commercial banks inthe form of cemand dapat, and above cash deposits of the peop with the banks. 40. Define high powered money. ‘ans. High powered money refers to monetary base or base money in the country. It ind Uieurency heldby the people, (i) aut cash ofthe commercial banks, and (i cash reserves of commercial banks with the RB 21, Define money supe. ‘Ans. Money suppy refers tothe otal quany or stock f money valabein the ecoromy ata pont of 1A mrouctory Macronconomics Be 12, Wite the components of money supply. ‘ans. I) Cureney with the people, (i) Demand depasis with commercial tanks, and (i) Other depos. £3, Who are the suppliers of money n India? ‘ns. (i) The government of the country, (i The ental bank ofthe country, and i) The commercial banks, 14, Define demand deposits. Ans. Demand deposits of commercial banks are these deposts which can be withdrawn from the bank on demand ar by writ a cheque anytime 25, Define term deposts. ns. Term deposits are those deposits whieh cannot be withdrawn fram the bank as and when needed or by writing a cheque anytime. These depos iwolve a lock period 2. Reason-based Questions (Comprehension of the Subject-matter) Read the following statements carefully. Write True or False with a reason. + Double coincidence of wants is a essential requirement of exchange ‘ans. False. Though its an essential requirement fr the barter economy, na money economy exchange can take pace without double coincidence of wars. 2. Face value of money i always greater than Is intrnsie value ns, Fale. Incase cine are made gold and slvr intrinsicvalue of money may ver time exceed ts face 3. Stock of money with the money issuing authors san important wumponent of money phy ‘ans else Supply of maney does nt include the stock ot with the money suing authorities. 4, Flat money is the same as fiduciary money. Ans. Falke Flat money isthe money backed with order ofthe government wheres duciny money isthe ‘money backed with the mutual rus between the payer and the payee 5. Money supply includes demand deposi of the people withthe commercial banks Inns. Tue, Demand deposits ofthe people with the commercial banks i 8 component of money supe Because, these depesits ae converted in cash ustby writing 2 cheque, 6, Double coincidence of wants i typical feature of monetary system of exchange, ‘ns. Fale. Double coincidence of wants sa typical feature of barter system of exchange 7, Money hae separsted the acs of sale and purchase. Ans. True, With the introduction ef mane an indvidval can buy or sella ting without sing or buying anything in return 8. There s no medium of exchange inthe barter system. ns. Fale. Under barter system, goods themselves are the medium of exchange for goods, Ofcourse, thee is no common medium af exchange ike money Theres no common unit of value in barter system, 8 ns. Tue. There is 2 lack of common unit of exchange in barter sytem, Evolution of maney offered @ common unit of valve Money 145 a. os. in v. as. x. ans 14 ans as. ans 16. ans. 3, HOTS & Applications 146 ‘woney may be used asa commodity. Money ry nen se ake (emma wal of mene? cexcoods ite fae vale money valush van money the money ected a 3 red om he Crete pone rane whose mney value more aN He commodity vue Tpontary sem of exchange etaes Much Be exchange than the barter t=. Mone ear ee bare 9s) 305A Jub coinidence of wants ti enesure of money supp hudson tes a eld by the peor. Fake, tye Notes an cons el byte people + Demand Deposits » Other Deposits stoner sapny inte economy refersto ote fA TONE by the RI Money suppl i ne econay incase oth ak Tpacaed by authority of te FN a Fae, Mere ay money (backed by tua rust been he FEE ‘and the payee vermmerct banks pla norten he stockofmoney ON the economy. Commer pry park const re stk of monet PEM the economy by wer OF aearreeesvth he banks 38 mre COTPIET snaney supe Cash rene res wth he bark ae nota component APS) Sooty. Because cash se N659 Fels Ca ery wn ened a pact NEY MPP “wnatia meant by an ideal supply of money? vant rou Maney SUB wn ea she total purchasing power voc gotance hte suppl of goods anasevces me eennary,s0 thatthe exon Oe “ipina nfatonary of defiionary staons Commodity vale of money hasnever been greta he face value (or money vl) 1s Commo atement fae, Ingoodcld davs¥hen cone nadeof gold and siver comme Ne thee ey refering oe vue ft cota cin) would sometimes exceed vate me cr wy cars were sores mes 28 Sold as ameta Peet aniahpeesarcneyiese oonren cr commercial bans wth the bank? bank incaret, gh powered money refers f0() Co th publ, (i vat cash No ean cash reserves oft comers Bas th ehe RL ponay becomes a cormmady when inn va of Money ‘exceeds ts face value. O refute Cee statement come ecnse when HU exceeds face vale of a est ton cane gl aver cs, many Suse = * ‘commodity mong er of money ssid as 2 eammodt pc on high powered money wiiaaro curb onthe creation of reat by the commercial Inthe economy. Do YOU agree? laa econo Meme carek Tis becuse NEN Po inciudescurrenc Ye Bel cas reserves ofthe cover ant oe hen serves aa monetary ee ne ena. Acton powered mene ‘il definitly ead 1 tne eareaton of ere by the commer a banks 4. Analysis & Evaluation 2. Explain how introduction of money hasled tothe expansion of markets, ‘ans. Following observations may be noted inthis regard Ui Introduction of money has led tothe expansion of markets through the expansion of exchange. Because, barter sytem of exchange requires ‘double cineidenceof warts while tie monetary system does not (i Money has led to the emergence of financial market and financial intermeduries (banks and other financial inestution). Availabilty of funds, both for purpose of consemption and Investment, ha substantially Increase, Consequently, markets have expanded (i) Introduction of money hos boasted the mebilty of capital across efferent parts ofthe work “This has led tothe expansion oflabal markets through FOI (foreign direct investment) 2. Do you agree with the view that the exess of money supply hinders the process of economic row? Give reason. ‘ans, Nes, itiscorect to thatthe exces of maney supply hinders the process of economic arowth. The following reasons explain this pont of view () cess of money supply is @ situation when purchasing power (aso called liquidity} wih the people is more than the esting market value of the goods and services aalsble Inthe ‘economy. Consequenti, pressor of demand mounts up on the avaliable supply of goods and ‘ervices This leads ta se the general pie level Ui treacess supply of money carinues to persist, the station af sing price level also continues to persis, This called asituason of infation-astuaton of ‘rice spr i) Persistent ination leads to rise nthe rate of interest. Imphing that the cost cf investment tends tore. (i) High cost of investment laade ta 2 cut in the uokime of invetment |y) When lnvestment dacines, the GDP growth aso dedines. ‘Thus, excess supply of money tends tahinder the process of economic aromth. It lowes the growth rate of rel GOP 5, CBSE Questions—Past 5 years (With Answers or Reference to the Text for Answers) : 1. State the mesning and components of money supp (Page 137,138] ; 2. Demand deposits Include (choose the correct ateratve: {2} saving account deposits and fd deposits = (b) ving account deposit and curent account deposits i (©) curent account deposits and fied deposits (0) alltypes of deposits [case (an 2017 ; or 3. Explain “ticulty in stoxing wealth” problem faced in the barter system of exchange. 3 [Page 135,136] [case (a) 20171 ‘a 74. Define money Us ts components. (ease f) 2017 [Page 124 Components of money are: () notes, i cin, i) banks cheques and dra, emoney.] Money 147 ee 5, State the two components of M, measure of maney supp [cose 2014) or . State any two components of Mi measure of money supply [case 2029 (58/19) [Page 138) 6, Define “demand deposits [case 2019 (58/4/29 [Page139) NCERT Questions (With Hints to Answers) 4, What sa barter system? What are its drawbacks? [Hint Barter sytem a system where goods ae exchange for goods. Drawbacks: (i) Ierequires double coincidence of wants {i tlacks common unit of exchange. Ai) tacks convenient means oF storage of value] 2. How does money overcame the shortcomings of abartr system? [hint Use of money overcomes the drawback of barter system of exchange inthe folowing manne (i) Use of money as a medium of exchange has overcome the cfc of ovble coincidence wants, Accordingly exchange has tended to expand. (a) Money faites storage ofvlue justin terms of paper claims, avoiding the storage of wood under barter system, Uli) Money act a standard unit of value which s absent. Ii) Moneyactsas an instrument of deferred payments. No suchinstrument availabe inthe bar system of exhanzel| {3 What ae the alternative definitions of money supply nina? [bint MM, and Mi (ee Abilty Zane fr deta) 4, What st money’? {hint Fiat money refers to money backed wth order (authori) ofthe government) 5, What high powered money? [Hint High powered maney means cash [coins and notes) withthe people andcash reserves of commercia banks 7. Miscellaneous Questions and Reference to the Text for Answers A. Questions of 3 & 4 marks each 4. Bela the evolution of money (Page 133,43 2. Define barter systern of exchange. State any two shortcomings of barter system of exchande. Page 134-4 '3. Explain anyone problem faced inthe barter system. Hew has money solved ths prabiem? (age 135, 1 4, Give meaning of money. Sat its ferent forms. (Poge 134,136 1 5. Explain the important forms of money (Page 136, 6, What s meant by money supply? State My measure of money supply. (Page 137.4 148 invodctoy Macrosonomies B. Questions of 6 marks each State the limitations (drawback) of barter system of exchange. How are these liitatiens removed ‘withthe introdueton of money? (Pace 135, 136) Maney iswhat money does” Exlan (age 233, 134] Define money supply. State and explain the different components of money supply [Fave 237,138] How does AB classy the supply of money? [Page 137,138] DOs and DONTs Yeu must understand that barter system of exchange is ch primitive economies. Monetary system af exchange ea characteristic of modem econames. Growth bf an economy frm an underdeveloped economy to @ developed economy) is deeply ested to the growth of monetary system of exchange. ‘Storage of money shoud not be misunderstd as ‘ile cas wth the people, People hold money (@ tomeet ther routine transectios, i ta cope with thet emergent needs in the near future, nd i) for purpose of investment (buying shares end bonds) Inte, RBtissues all paper notes, butnot the one rupee note. ls, it doesnot sue coin Hlesins and ne rupee netes are iseued By Mis of Finance, Government of nda, under he indian Coinage Act However cieulaton of the entre curency (rcluing notes and cons) conducted only y the EL [e M,,M,, M, Measures of Money Supply M, Measurement IM, is @ boarder concept of money supply compared to My. Besides all the ‘components of My, alsa includes savings of Ure peuple wil the post offices, Thus, M,=M, + Deposits with Post Office Saving Bank Account M, Measurement My salsa a broader concept of money supply compared to M;, Besides al the ‘components of M, it also includes (net time deposits (or fixed denosits/term deposit) af the people withthe commercial banks. Thus, 'M, =M, + Net Time Deposits withthe Commercial Banks M, Measurement MM, concept of money supply is stil broader-it is broader than even Mg. Besides al the components of M alsa includes total deposits withthe post offices (other than inthe form of National Saving Certificate). Thus, M, + Total Deposits with Post offices (other than in the form of National Saving Certificate) Aggregate Monetary Resources of the Country money supply in the county measured using My measure, is calle ‘ogeregate manta resources of the county. +s warrow Maney and’Broad Money Concepts of MOP ‘supply Narpmineton between narrow rnoney and bYORd ‘sometimes drawn, TMfareferenoe tothe measure used fF estinand "otal money supply inthe wn ee oF My measures ave used, then tS KGE "narra rn os ony Supply Mgr Ma eases ate use then itisknown 26 SBoad money concept of money SUPPM |e Indian Monetary System sreponetary system fers tote frm of MONEY ich circulates in te sono Airway of rderfautory ofthe GDS. TD sing paper CUTENCY 1 a nan monetary system described 5 272PE Curreney Standard paper curency does rot excuse the use oF Ia Both metal coins an Paper notes are eredt money in Ina. Te or tifference is that wile co Pepe mal denomination, paper nates. are oF FOS ‘denarination Note: Coins in india are nied legal tender paper nots in Inia are united egal tend ‘nena tha sina be vsedo sei payments oY oftimited value; pap lemeas pe used to sete payments of unre value e What Governs Note Issuing in india? Pee ceing in nda governed by Mirirur eon system. The enti Note is fone nas the backing of mirienum GoW reserves "wo points earetlly understood inthis context {p Gold eserves are just te miu rears © 175 crore) These are proportionate tothe curencyn culation. {a Money with the people is entity red money’ t cannot be con Me ser or eid heissing author. Gog em are eae Te stckto convert pape notes #0 214 Je The Concept of Liquidity Tiny ofan asset refers 10 ts comvetbiny rmoneyleash. Fast xia tan be corwerted into cash, mre Nau ‘Obviously, money the most liquid asset hequeavle depestsydemand dost ae hah HIE assets, Accord Cheaueat hat My neds oly those componssts ofS ‘supply ‘are most liguié sree depois or time deposited deposits wo TO chequeable 6 Te anna be witharawn by issuing chee Tse deposits are. th less liquid than the demand deposits sa msnghy Mand Mreasures of Toney UPDH nese such compo ermoney supply which areless avid. 480. tnvodutory/ Macroeconomics A a BANKING Money Creation bythe Commercial Banks 1m The Central Bank: Mecning and Functions ‘= ContrafMoney Supply by the Central Bank (in india) In the previous chapter, we noted that the commercial banks are an important source of money supply n the economy. Unlike the central bank, the commercial banks do not have the authority of Issuing currency: they cannot issue notes or coins. Yet, they are the suppliers ‘of money as they create money by way of demand deposits. In the present chapter, we discuss the process of money creation by the ‘commercial banks: how exactly the commercial banks create money? Process of Money Creation by the Commercial Banks Following observations explain the process of money creation by the » | commercial bank: : (i) Banks receive cash deposits from the people. These are called : {i) Banks lend money many times more than their cash reserves. (il) Money is lent by the commercial banks not in the form of cash ; butin the form of ‘ret enry‘in the aecounts of the borrowers. These credit entries are known as se {v) The borrowers can issue cheques against ‘credit’ (loans) in their 6 accounts. The cheques culate in the economy as money. GO} + = held by the people in the commercial banks 181 (vy Total demand deposits with the banks are many es ore ‘than ; Tae sah reserve of the commercial banks, This i because the te mercial banks know (by way of tei istorieal expenencl] Fe the depostors would not show up in the banks fl ‘withdraw all their deposits by way of cash (vin experience shows that withdrawal are general e908 10 revrgt demand deposts, the banks need to keep only 10 ‘cent of deposits as cash reserves (ui Al demand deposits (eld by the people) serve 3s money supply in the economy, ust like cash held by the people ¢u) Demand deposts serving as money supply fs called bar vcs money created by the banks, Because this is rcueting The sytem notin the frm of cash but in the Fort ofc trove by the barks tothe holders of demand deposits Mlustration Let us strate the process of credit zation withthe help oan xa For the sake of simplicity, we assume that: (i) There is a ‘single banking system in th the bank receives deposits of & 1,000. (uy cRR = 10% and it doesnot change. This reflects cath estes Wal banks as a percentage of their demand dep id work forthe creation of mo 1e economy and iit tive commerc ‘Table 1 shows how the system woul “Table 1. Creation of Money ina Single Banking System ‘at Round 2nd Round ardour tan the first round, bank receives deposits of € 1,000 ae ah osrves to tacte the abiity of € 1000's equal tO oecause cash reserve ratio is ~ 10% of total deposits) Wg (eta panks have excess reserves ~ € 1000 - € 100 —& which they can use for the purpose of lending: a When these exess reserves até loaned out, deposits oft re raised by & 900. The banks need to hold cash reseve5 300 or € 90, Now, excess eserves ofthe banks 9002 § ro which canbe loaned. This process continues total deposits are € 10,000 and cash reserves ae € 1,000. 152 _Invoductory Macroxonamics “Thus, if cash reserve rato is equal to 10%, initial deposits of & 1,000 allows the bank to create demand deposits up to & 10,000. So that, 1 x Demand Deposis= cag x CashReserves 1. Faye ** 1,000 = 10 * 1,000 ~ 10,000 Summing up, we can say that money creation by the commercial banks depends on two principal factors, as under: (i) Cash Balances with Commercial Banks which they can use as cushion money (emergency fund) forthe creation of credit Higher these cash balances, greater the money creation (or credit creation) capacity of the commercial banks, and (jd) CRR: Higher the CRR, lower the capacity to create money. Besides the CRR (cash which the commercial banks ought to keep), the banks may hold excess reserves, as ‘vault cash’, Higher the vault ‘ash, lower would be the capacity to create money. Primary and Secondary Deposits Primary deposits are cash deosts withthe commercial banks bythe people These cre. port of ota demand deposits ofthe banks. ‘Secondary deposits ore those depsts which ate on account of lane by the banks tw the people These ar ao part of ata derond depos of the banks Important to note ti, thet whl primary depstsIndate saving ofthe depoetors he banks, secondary depos insect brewing ofthe depetar rm the bon. Sacondrydepasts are abo caed Derivative Deposits. Teta Demand Deposts ofthe Commercial Banks = Primory Deposits ofthe Commercial Banks + Secondary Deposits ofthe Commercial Bank. ERR and Credit Multiplier In india, CRR is determined not by the commercial banks themselves but by the RBI (Reserve Bank of India). Therefore, itis also called LRR (Legal Reserve Ratio) ‘Aso, the commercial banks are required to keep the stipulated (egaly required) cash reserves not with themselves, but withthe RBI (GF course, the banks can keep excess reserves as ‘vault cash with themselves). (nce CAR is known (as fixed by the RBI), we can find out ‘credit Mhulipier, or the number of times the commercial banks can create Ete, per unit of their cash reserves withthe RBL Rée in cost of capital —> Fn demand] for erect => Fallin te suppl of money —> nflion ison Fallin Bonk Rate —> Fallin srkt rate of terest —m Fallin cost of capital > Ris n dem far credt—> Risz inthe suppl of one? —> Cefavon s corral (2) Open Market Operations: Open market operations refer to the sale and purchase of securities in the open market by the RBI on behalf of the government. By selling the securities (ike, Nationa Saving Certificates-NSCs) in the open market, the RB! soaks Tiqudity (cash) ftom the economy. And, by buying the securities the RBI releases liquidity When liquidity is soaked (as during inflation), cash reserves the commercial banks are squeezed, implying a cut in ther creation capacity. On the other hand, when liquidity i rele (Gs during recession/deflation), cash eserves of the banks tend. rise. Implying a rise in credit creation capacity of the commerd banks. ‘Thus, inflation is corrected by selling the sccurities and soak liquidity, while deflation is corrected by buying the securit and releasing liquidity ‘Sale of Securities by the Rl —> Soaks lquiity and feed toa fll n cash resarves of Sah neil banka —> Fallin cred creation capactt ofthe commercial banks —> Fal supply —> Inlaion is contra Purchase of Securities by the RBI—» Relases Iquity nd ead to ise incash ese ceinmeril bork Risin cred creanen capac of the commercial banks —> Risen Supply —» Defatin controlled ‘Two Types of Open Market Operations ‘Tere are two types of open market apeatione:() cight anc (010 ‘urigtt open market operations are permanentin nator: Theea are scssed above. The typo known as rep op|en market aperations.n such type of operations, ere @ Topurchase and ese of sour (unk inthe Ast 9B) (2) Repo Rate: The rate at which the RBI (central bank) offers period loans to the commercial banks by buying the govet Securities in the open market is called ‘Repo Rate’. in fact, ‘2 Repurchase Rate. A repurchase agreement is signed by the partes stating that the securities will be repurchased by the commercial banks on a given date at a predetermined price. In other words, the Ral issues a loan cheque to the commercial banks by buying from them the government securties. But, i carriesthe agreement of repurchase of securtiesby the commercial banks at the predetermined date and at a predetermined price. During inflaton, the cost of capital is increased by increasing the repo rate. This lowers the demand for credit and accordingly, the supply of money in the economy, as desired. On the other hand, during deflation, the cost of capital is reduced by reducing the repo rate. This increases the demand for credit and accordingly, the supply of money in the economy, as desired. ‘ive in Repo Rate —> Ris in cot of capital —> Fal in cemand for crit —> Fall in snp of ‘money by tha commercial banks —> Inflation is controle Fallin Repo Reto —> Fallin cot of capital > Riso in demand fr credit —> Rise o sp of ‘money bythe commercial banks —> Defltion & contol (4) Reverse Repo Rate: The rate at which the RBI (central bank) accepts deposits from the commercial banks (through government securities) is called ‘Reverse Repo Rate’. It is also called Reverse Repurchase Rate. In this case, a reverse repurchase agreement is signed by both the parties stating that the securities will be repurchased on a given date at a predetermined price. Reverse tepo rate allows the commercial banks to generate Interest income, When reverse repo rate is lowered, banks are discouraged to park ther surplus funds with the RBI Instead, the banks may use ‘these funds as CRR-funds withthe RAI. This leads to aise in credit supply (money supply) by the commercial banks. Accordingly, supply of money is enhanced in the economy, a5 desired to control deflation. On the other hand, a se in reverse repo rate may induce the commercial banks to park more funds with the RBI to generate interest income. This lowers their capacity to offer CRR-funds to the RBI forthe creation of credit. Accordingly, supply of money is reduced in the economy, as desired to control inflation, ln Reverse Repo Rate —> Less funds are porked by the commercial banks wih the RBI ro fate intrest neome >. More fund are used 2: CRR funds with te RB, fr the cretion of > Sippy of money increases —» Delton i cantafed in Reverse Repo Rate —» evs funds are parked by the commercial banks with the RB ate interest income —> Less funds ae Used as CRF-fnds withthe RE for he cestion of > Supply of monoy decreases — Inflation fs contol 159 (6) cash Reserve Ratio RR): refers to the minimum percentage Ca an’ total depostsrequied be kept with the RBI Ws rep rom time to te to rezvate the fixed by the REL in the economy carislovered, and cof money i to be increased, Sr rmoney ist be reduced, CRR IS raised. jive in cRR—> Rein 0, session fora ven mount ‘rdemand deposits —> Fal RS ne controled. sor RR —> Fallin sh ese Fal in CR pc conmeroa nena —> Oe" (© statutory i patio (UR): Every bank staintain a fined percentage oF 1 fore of ih Mipets, called SLR. The liquid a5 sesitiy unencumbered =PDOVS {like that of CRA) i fsed We. To decrease the SUPDIY OF Men ases SUR. Accordingly: f ced. Converse in the econom) {forthe creation of ith th ania sin —> Re bdo oe raid ig comme bani ere Rise vay of funds 0! ots thine RBI —> Fat roney supely the com otra > Inflton is contr Fallin suk—> Fal aps be ACE Fall getiy f uns Fx ORR PS beth the ReI—> Re the rate efi i conwoles (8) Qualitative Instruments of Credit Control Qualitative instruments are those instruments of credit contol ny. These Instruments ate ct sectors f Focus on select setors of the eeone tet Jecrease the supply of MONE! selec svhich are the principal 50 pans wth themselves = sump the instabilty placed in thee cate (1) Margin Requirements TP margin requrement refers wetce between the cute Vale ‘of the securty off ered clea) and the valve er granted. Uf person mortgages Ws house worth & 1 crore with the bi ero € BO lakh. The margin reaurer eo ak. The margin requrement& gories, as under 160 voductry Macroeconomics ‘money needs tobe reduced. The margin requirement is lowered when the supply of money is to be increased. Often the margin requirement is kept high for speculative (trading) activities. ‘ise in Margin Requirement —> Fallin demand for crelt > Fall in supply of ered by the ‘commercial banks —» Fallin money supply —m Inflation controled Fallin Margin Requirement —> Rise in demand for crecit —> Rise in supply of eve by the ‘commercial banks —> Risen maney supply —> Deflation controled, (2) Rationing of Credit: Rationing of credit refers to fixation of credit quotas for different business activities. Rationing of credit is Introduced when the supply of credit Is tobe checked particularly for speculative activities in the economy. The RBI fixes credit quota for different business activities. The commercial banks cannot exceed the quota limits while granting loans. This restricts the supply of money inthe economy, and inflation is controled. On the ‘other hand, rationing of credit (if aready in practice) is withdrawn to Increase the supply of money. This controls deflation Introduction of Credit Rationing — Oacraases the sypaly of credit by the comimeresl banks > Decreases the supply of money —> Inflation s contol. Withdrawal of Credit Retioning —> Increases the supply of rect by the comneci banks wa inereases th supoly of money —> Deflation s controled. (2) Moral Suasion: Iti like rendering an advice to the commercial banks by the RBI to follow its directives. The banks are advised to restrict loans during inflation, and be liberal in lending during deflation. Check the following flow chart for a summary statement of the quantitative as wel as qualitative instruments of credit control Instruments of Credit Control Quantitative instruments | Qualitative Instruments Narain Requirement atoning ofcrede eral Suason Statutory quid Ratio Srerecitcontol crear cone (Open Market Operations anting 161 ————oooosts— ze : s a 3 z é § 3 3 & z a e b z i gto select sectors ofthe economy. Flow of rt nse pry sco) maybe EDLHEE aut stimulating reduction it ce ere Tis iw postive apocationofslectve Ta vetyols On the other hand he cen sae eet ret te aati of rea 12 Thor priory) sectors. General bank 3d of nto, ovat of cet (rae ees ike storage of fod ei ca Pegged This sa negative appa of the sieve credit contr. Points & Revision Window “Money Creation by the Commercia! Banks: Gommertilbarscontsite tment suRpNV By Cean gs cay adracing ans Gr tems of Gemand st They pe ore than the cash reserves, Tey 9 4 Pa ar nova experience thatthe depose bass oe ease to whan ther epost, Ths ey towarste epostoldrscan be mana aaah percentage ofcdepsts 25a ess, 1 reat multiple er cas series th the Rn nl, CR aed BY Ne AY ‘esnows the mb of ese commer bans ca ene Teak PSG eee banka teenie barking of@ cour FO S18 Set bea Trunctions (1 Bank of suing notes (i) Banker 9 he governent, (8) Banker’ bank and super SOV tate ofthe let eso Csodian fren chan Yi clearing house funesen, (Co of credit. aanrsay to conte sup cretion NECSTETE yg core ie poor aie dein he ecnert. NMS enetarY the Suan pede) coarse nse and ( OURRISS "seu ae Prope a called instruments of cred contra Jauanttative Instruments of Monetary POY: ay eves: arate (9) poate, an (Reese PO rate {ih wo pole ais: (a RR, and (SUR (ii) Open market operetons. qualitative instruments of Monetary POUCH: i) Margin requirement, Gi Rationing of cre, and (i) Mora suason. 162. invoductry cr EXERCISE Objective Type Questions (Remembering & Understanding based Questions) ‘A. Multiple Choice Questions Choose the corect option: 1 In the context of commercial bank, which one ofthe following statements i correct? (a) Hote-suingauthorty ofthe country (b) Creates creat on the bass of eash reserves (e) Accepts deposts ofthe general pubic (4) Bath band fe) ‘Commercial banks create money by way of: {a} time deposits (b) demand deposits [e) weasury ils (4) bilof exchange Which ofthe fllowing snot concerned with banking organisation? (a) Bankrate (6) Fscal deri (@ Creditcreation (@) Cash reserve rio Credit cards sued by the Banks (a) encourage consumer spending _(b) increase aggregate demand inthe economy {e) both (a and (6) (¢) none of these “The maln aim ofthe commercial banks is: {a} social welfare (0) toearn profits [c} toprovde services tothe peopled) none ofthese Maximum ereit thatthe commercial banks can legally create depends on thelr: (a) gold reserves {) cash reserves with the Rl (6) statutory liguty aio (a) term deposits Term deposts are those: {a} sesinst which ne cheque can be issued [b) aginst which no interest spa to the depositors (€) which area part of supply of money (4) none ofthese “The percentage of demand deposits which the commercial banks ae legally required to maintain as their liqu assets is calle: fa) ca (6) repo rate fe) sun (a) reverse repo rate SUR requires the commercial banks to bull thee iquid assets by way of (a) reserves ofcash (b) reserves of gold (c) reservesof unencumberes secures (dallofthese Central bank's an apex bank ofthe country that: (a) contrat the entre baring system ofthe country {e) ssvescurencr fe) acts asa banker tothe government (0) alloF hese sorting 163 “an. in india, the central bank is: rear teres ty Fedele i) esere Banktna te sh (oa) ean one mente ane et indeed oa (ha Gane wa TOT ta ag Tomeens 13, crest consa mes Cent coment eres on Ip emerson feito 1 eer angen money PP (6) none oe eee tloneg wrt eineaet Se tre ak i) sonkrate fo) wanseed foatng 1 ings nce ne ae en we mee eres “i earesewerat® (wort s1300 (Reporte craton Se ncare prom Sve ae Penarth sun ta dg keaneanesutnet ley? an instrument of {p) thecommercial {a} none ofthese requirement, vaaby of eatin te eeeren (a) creases Tb) decreases (e) unchaneed {a) none of these 18, inflation ist be combsted the FO {Gy rates SLR and fers CAR {ey lowersin and raises CRR {Cases both CR as well SER {@) vane ofthese 49; tf recession sto be combated {E) bankateneedstobelowered {b) caf naadsto belowered {e) both (2) ant) (6) eepo rate needs to 16, Open market oF {oh the central Bank je) both (a and 1 -y7, wath an increase in ari pe lowered and CAR needs tobe ase 20, Reverse repo rate {ay gonerates inerestincame {b) feineressed to curb ntason fe) isnot policy ate {a} both al nd Answers Te 2) 2 A SO) To oe ce 20 ae ER apy seca alo 204 Le 2@ Be we BO roeconorks 6A Inosuctoy Moe 10.18 20.16) 8. Fillin the Blanks 1. Commer banks contribute tothe supply af maney by way oF (loans cashieans in demand deposits 2 deposits aise on account of loans by the banks tothe people (Primary/Secondary) 3. Incase, commercial bank ast get hancial accommodation rom anhere, It spproaches the asalastresort (cooperative bank/central bank) 4 relates to instant (immediate loan requirement ofthe commercial banks (Bank rte/Repo rte) 5, Demand Deposits = Prmary depos nk deposts/Secondary deposits) 6. fy sling the securities Inthe open markt, the RB qui (cas) fronvinto the econamy, [soaks/releases) 7 Rationing of criti the method ta contol money supp in the economy. (quanstatve/qualitative) 8, Asan advisor tothe government, central bank frames polices to regulate the (capital marlt/noney market 9, Central bank conducts to reguate exchange tate ofthe domestic currency. (managed foating/dety foatrg banks which they are required to maintain as amisimum percentage 20, guid assets ofthe comm oftheir total deposit refer to [cosh reserve ratio/statvtory iui ratio) 1. loans in demand deposits 2.Secondary 3. centalbank 4 Bankrate 5, Secondary deposi 6.20aks 7. qualtative 8. money market 98, managed floating 10, statutory quit ratio ©. True or False Si India, LAR is determined by the commercial banks themselves Banks end money many times mare than their ash reserves withthe RB Higher the CR, higher the capacity te create money. “The cantrl bank focuses on growth and stability ofthe economy. ‘Open market operations ae conducted by the RBto regulate the supply of money. When the supaly of money isto be inereased, CARs raised bank isa quantitative method of eri contr Creat creations the principal function ofthe cen Margin equiren The noes issued by the central bank ae an unlled legal tender. With atoning of creat, supply of money is reduce. oswes Pee ee 1 Lfoke 21ue 3,false A.true S.True 6.false 7.false 8. False 9.Tue 10.True tanking 165 ip Fn bythe comers bat tu berate depos iy Advisor tthe amet rises ‘Cstng Hous alderman ese {er primary depot {e conmeriatonk tw Pr city deposits fhe Dai (o) Notapat oft {ay contra (ey Secondary sem05t6 use fcty rn coturn by matching tem wh u enn crc que of aeatie a ners in ColuM E od tn feesby te fren tm cy sco 0 cin out nswer Tecan bank) oes lar Ho Answers Jt (0.4 (21 fam. -yery Short Answer’ Objective TYP ‘questions: 1 ute ce 1 Mt eopete ara 2. befine primary depests eps with the corer Bas oF ME people. These re 2 ‘ane, primary deposts ae cs TJemand depasts of the bars +, hat ae secondary depos? ary ene des which af na cf loans by the bas 20 th tra ans Tres ae a0 cae ‘ane, Secondary devoel ‘These ate refiected deposits 4, whats ans, cent ba fpaandal ster 5, Define CRR enemas i ‘ans, ch ash reserve at CR a aso parentage a SP re part of demand depost a central bank? Mic is an apex institution of gulates the mone ifthe count «acount that controls 208 4166 inrotucory Mocroconoes jf statements: pessothebonks ae 0 parol Whats SUR? SUR (statutory liquidity ratio) efers to quid assets ofthe commercial banks which they are raquiced tomaintain as a minimum percentage of ther total deposits Define bank ate The bank rate isthe rate at which the central bank ofthe country offers loans to the commercial banks by discounting the secures. It ao called discount ate: the rate at which securbes are discounted for purpse of ean. It doesnot invehe any collateral, adit doesnot alow repurchase of secuites, Whats repo rate? Repo rate the rate of interest at which commercial banks ean raise short-term loans from the central bank hate reverse repo ate? Reverse repo rates the at of interest at which commercial banks can pak hel surplus funds ith the central bank, for short period of te, \What do you mean by open market operations? ‘Open markst operation refer to the sale and purchase of government securities the open market by the ental bank ofthe country. Define margin requirement Margin requirement refers tothe diference between market lie ofthe security efered for loans and the amount of loans offered by the commercial banks Define moral suasion. \Moralsuasion refersta persuasion as wellas pressure exercised bythe centralbankonthe commer banks to be restricted and selective in lencina curing inflation, and w be liberal in lending during deflation 2. Reason-based Questions (Comprehension of the Subject-matter) True or False: Higher CRR implies higher capacity to create ced False, Higher CRR implies lower capacity ofthe commercial banks to create credit. Because credit ‘multiplier ithe recipracal of CAR 8y purchasing government securities inthe open markt, the central bank intends to release more money supply in the markt True. Central bank buys government secures With a view ta nrease the money supply, Purchase of secures by the central bank leaves more money with the people. also increases nul ofthe commercial banks to create more credit (in tems af demand ceposis Margin requirement f raised bythe central bank with a view to increasing money supply False, To increase money supply the central bank lowers the margin eauirement so that people are induced to rae loans and the banks are ble to eeate more cedkt by way ofloars. During periods of depression, commercial banks are advised tfllow dear money pley. False. To curb depression, supply of many needs tobe incresed, Accordingly, commercial banks 2re advise to pursue cheap money policy “The central banklea lender flat resort Tue. A central bank advances loon to © commercial bank when the later fas to get financial accommodation from anywhere against approved secures. 6. The central bankis a banker to the government. ‘Ans. Tue, Asa banker tothe government, central bank kes the account ofall government banks and ‘ manages government treasures 7. The commercial bank has the currency authority ‘ans False. The central Bank is the sole suing authority inthe country. thas the excisive rt of note ‘suing 8. In Indi, CRR and SLR ae ised by the commercial banks themseves. ‘Ans. False In india CRR and SLR ae Fed bythe Rl 8, Demand deposits ae equal to cash deposits with the commercial banks, ‘Ans, False. Cash deposits are only primary deposts with the commercial banks. Deposit created by wa ofloans are secondary depos Demand Deposits = Primary deposits + Secondary deposits 10, Secondary deposits of commercial bank are always les than is primary depos. [ans Fale. Secondary depos are manjimesmere thane primary deposits ofa commercial bank, Becau primary epost are cash deposits, & commercial bank can parks cash with RBlas ash reserves. legaly create secondary depos (by way ofloans] many times more than their cash eserves. 11, When CRR is alsed, credit reaton by the commercial banks isnot necessary reduced ‘ns. True Because commercial banks may have some excess reserves, 112, CRR and SLR work opposite to each other ‘Ans. False, CRR and SLR are complementary to each oes Arise in these ratios conto the creation credit, and vice versa 13. Market rate of interest tend to be positively relate to the bank ate, |Ans. Tue, Ineree or decrease in bank ate sate followed by increase or decreas inthe market cf intrest. 14, Repo rate isthe rate of interest charged by the bank on commodity loans. ‘ans False Repo rate is that ate a which cenal bank offers short torm loans to commercial banks. 15, Higher repo rte implies higher credit creation capac ofthe banks. ‘Ans. False, Higher rea rat implies lower credit cretion capacity of the banks. Because, banks are induced to borrow quid (cash) fom the RB for enlarging their cect market, 16, The commercial banks design alinstruments of monetary policy andthe central bank contro th ‘Ans, False. Central bank designs al instruments of monetary policy and also contol them 17, The commercial banks are the controller of money supp ‘ans, False, The central bank controls the money supply in the economy. The commercial banks contribute to money supply by way of credit creation 18, The central bankissues currency onthe basis of CRR- ans. False, Central bank doesnot sue currency onthe basis ofCRR. The ratio CRR igacs credit reat capacity af the commercial banks. 3. HOTS & Applications 1. ifthe commercial Bnks buy government secures, their capacity to create credit is reduced youagree? [ans Yes, the even statements correct. By allowing or inducing the commercial banksto buy gover Secures, the central bank soaks cath balances ofthe commercial banks whic they could treats credit. According the cred creation capacity ofthe commercial banks reduced. 168 Introdvtory Hacoeconomes Isit correct that when margins are rase, demand fr loans is negatively Impacted? When margins are raised, the diference between the markt value ofthe security offered for loons and value of loans granted became high. It snow expensive forthe people to take loans from the banks. Therefore, demand fr loans reduces inthe economy. Thus, the gven information correct Isrepo rate an instrument of qualitative credit contro? No, repo ratelsaninsirament of quantatve credit contral timpacts the avait aferedt crass all sectors ofthe economy. IFCRR s lowered, ivestment demand must ise, Defend or refute. Yes, the above statement Is correct. CR is lowered, crelt creation capacity ofthe commercial hanks Is enhanced. Higher avalablty of credit and at lower interest rate must leac to 9 22 in investment demand, How is quantitative credit control ferent from qualitative creit contol? ‘Guanstative erecie cenro refers to overall credit conto n the economy, affecting sl sectors of the economy equally and without discrimination. Qualitative credit control refers to seective credit control that focuses on allocation of credit to alifrent sectors of the economy. Flow of credit I ‘encouraged tothe priority sectors, while itis discouraged te the non-prarty sectors Commercial banks create credit only on the advice ofthe government. st true? No, this 6 false, Commercil banks do not create cracit only on the advice of the government. However, their capacity to create credit depends on credit policy of the central bank of the Commercial banks donot have the note issuing euthoity, ut they do contribute te money supely Inthe economy. Comment, Yes, the glen statement Is corect. The central hank isthe sole authority of issuing notes Inthe country. However, by advancing loans through credit creation, commercial banks contribute to ‘money suppWy in the economy. What roe does Rr payin the creation of ret by the commercial banks? CR (cash reserve rato) ets a limit up ta which commercial bank can legally crete cre. Example: If CAR » 4%, it implies thatthe commercial banks can erste credit (by way of loans) 1 ae “Rate cuts might not be imminent”-Reserve Bank of nla (The Ecoromie Times} Why Ris nt ready to cut the rates? Write your opinion. Here, rte cut refers to repo rate. The RB! believes that a cut In repo rate i gong to fuel reall inflation which is already high. Hence, 2 cut in repo eat [which wil increase money supply in the economy) isnot recommended ‘RB fowers repo rate rom S.A0K to 5.15% th october, 2019) ‘Anaiyse the economic value of this statement from the viewpoint of (i) the households, (i ovestors, and fi the economy. ‘Actin rep0 rate the rate at which commercial banks can raise loan from RB) is expected to be followed by acutin markt rate of interest (the rateat which the commercial banks offer loanst the Deople. tts expected to impact the households, investors, andthe economy as under: (0 impact on Households: cut in market rat of interest (olowed by 2 cutinrepo rate) sexpected te induce borrowings for the purchase of consumer durables, 2s wel a houses and ats. Also, ‘the existing loans rased agains foating Interest rte) will naw attract lower EMLImpying 3 ‘rect monetary benef tothe households macrum p25 ne ( 25) otteicahresars tht senking 169 {0 bmpacron theives: Asareuofac ne maretrate ofirterest te cost boron tthe cot of apt wi ese. AEN serene expected to nerease COE Ui Sreas of production acti uy umonct on the Ezoromy When demand robes rises, aggregate demand i impart gvo voe, Aepegste dean a0 NS sarap investment expensture eek Because both eT rasan sen ee Sect qate eran, Tus the eve of nna co Pemected tore along wth te le of ae poset econ, Acar he eT “Gor level is exoected iB erehvnga sein the growth ate of GOP 44, Analysis & Evaluation +. How in your pinion ee reson By he cme Tanks accelerates the pace of eco0om trom? wre two obseratons ox Patong observations ay be ete int 6" rota ce enti accelerates the proses of Credit for purpose of ivestment serten-2- rei eeaion cones tothe Pose of growth by expanding se ofthe a gas Geran), asthe oat fee rE urchase of consumer drables iNT 2. Howimproverent in bankinghabits ofthe people pushes upcredt avai fom the eT bonks? ans. nabs hepsi rsa inehan when ba moneys depoated wth te commer eel, pezordingly, cash reser mare a Soka trea. Higher cash eservent oaks enable tem to depost more care pas Hema ons, MB ‘deposits with the RBL Bes wi th ste later treats Oe Snap of loansiceat. Accord career ve corer Dns Tease 4, vow can Jn-Ohan Yojana beuseaasaninsromen vnerease supply of maneyby ene com banks? ans. ban sono be popuatnin a os anOkan oan A eo open ther bank eeu WHEN Mrapunts are opened then some Peat ete poste (ech MME i People is bound to reach the ca pr ah deostsor mary depsts, TH rer Pembles commeil bens tn ste a eres wie cena bank AC sR erap reserves wth the Rl = € 10 seth by expanding tre vali sna oRR = then the 20a demand depois Ne banks can erate = ayy 2.50000, Tiss haw an-Dhan and ay bese =n insurent 9 icrense Supply of by the commercial banks se hath Government te fol 0 COM CEST even when a series of iy ha eae the textbook oF MACORSENOTS, ‘aps Monat rears of comatng/eonvONrs CAs Wes argely on mocerating/oweifl Monn esos aa ere by marge saa eat cstier ana ict te seorese suppl side ofthe robler. eet of te nar hain a fain 7S) ‘been tregered by (led BM We ne a esses ae bose (nrc, sappy of farm output) #E mat PPS whining (aes TO nroductory Maroewonoris i) ae 1 ofbocrowing 5. false the impact of demonetstion (af $00 and 1,000 rupee increase ass commercial banks nthe Indlan economy. ‘ans, Demonetisation has led to huge deposts of eash in the commercial banks. Primary deposits of 1} on credit creation by the pe demand i the banks have risen significant, Ths enables them to Heep higher CRR-deposts with the Rl pedir re accordingly credit creation capac of the commeril banks is expected arise. withthe level 5. CBSE Questions—Past 5 years | ctl toe (With Answers of Reference to the Text for Answers) 1. plain ‘government's bank funtion of ental nk — Explain “banker to the government” funetonf he cena bane peso economic sia plain the bank of issue function of central bank Page 154) | 2. Government of India has ecenty launched “ln-Dhan jan! aimed at every household in the ‘county to have a least one bank accaunt. Explain how depois made Under the plan are gong to ffect national income ofthe county aby of [Wh the introdution of ln-Ohan Yolo’ by the Governmet of Inia, milons of people have tecommerca ‘opened ther bank account. Thishas enhanced primary deposits the commercial bans. tison the ban ofther rar dept ash ceposts) that the banks ae able to rate secondary depos phon. Instead Ileeds to expansion of ere inthe franca marke. According investment tends to se. Higher eserves of he investment east neease national income the courey Brow inil 4. plain the “bankers bank Function ofthe central bank ft. Aecordingly Te Currency isisued by he central bank, yet we sy that commerchl barks create mone isthismoney ceation by commercial banks Hkely to affect the ratonainenme? Explain the commercial ‘why do we say that commercial banks create money while wea sa thatthe central bankhas the sole ight to ezue currency? Explain What is the likely impel money creation bythe commercial sto increase banks on national income? fa = 10,000 [Money supply hastwo components: curreneyand demandes, Curreneysissued bythe central nc whereas demand deposits are creted by the commerea banks. They ereate money in the % £10,000 = form of demand depos elated tothe loans offered by ther. Demand deposits ofthe commercial banks are many times mare than theicash reserves, This sbasedon the historical experience ofthe banks that cash withdrawal of funds is only a smal percentage ofthe total demand depos. ‘The money created by the commercial banks inthe form of demand deposits is mainly used for Investment or production purposes, ny rein Investment leadsto many imes more increase inthe atonal income ofan economy, via, the mulipir effect) ply of mone of monetary lowering the I does nat 6. lain how “bank ate isl in controling credit retion? Page 157,158) 7. plan how open market operations arehelpul in controling edt [Page 158) 8. Explain hw ‘margin requirernents' are helpful in controling creat reation. [Page 160,161) 6 by) the law tion 5} eal Bonking 171 <9: papi there fa reser raiin contig rea enh. {cose (an 2016) {age 160) 40, fapan how report’ canbe lpn contoing credit reation {page 158, 1591 11, explain the ole of "ever {case (a 2036) repo rae in conraing rest eestor. {case ap 20161 Or teoling money SUPP {case vetn 2017) plain the role of ‘eserve repo rate! con (page 3591 sa. at of ata depts that» carmercal bank aso MP with Reserve 8 [choose the correct akernative) {a} statutory guy rao {c) Cash reserveratio liar 13. bol sank of nas called case Ochi 2017) {b) Depositrtio (a) Legal eserve rao nthe proces of rei eatin by commercial Bars {case (a 2007) plain the money eet uneton of emer ani {cose (F) 2017) {page 151-1531 (case (F) 20 44, feporteisthe rate at which fae cal ants purchase ovement seus FNM central bank terme banks an akeloans om he cn) Pt © cormerathanacantee the Gepost wih he cnr! nk (Ay shor term oan are aven by omer BaNs (ol 5, boplainthe “arsingreserve equrement* metiod of edit contr bythe cena Dan. (Page 1601 [cose (F208 reserve ratio Tre vryng reserve eguiemert she same as ag re determined by enose re coe teste) (CSE 201 36, Creit creation by commerce {a} Cash Reserve Ratio (CAR) {oy Sattar Ligidty ato (SLA) [e) nil deposits {@) allthe above (Wo 117. Whats monetary po Monetary policy i the potioy pursed ‘economy enon navumertsaf monetary pate (ese ae Market operations. Page 157-259) camara eo tment of recon af ered the Reserve Bank of nde sage 157-3611 {case 2019 (8 19. Define creit mute: uments of monetary Pay case ly of money In ey State any the in by the cera bank to regulate SUPP cash Reve Ratio, an ih at role does playin determining he cre mane of oe Sone? Use a cuetistration © ex case 2019 582 {credits tote numberof ives re vrnmercal banks can create creat pet Ut Kere mut the Lees cet BN OM CT ‘banking sytern in the cl ca ape power ointvence te supp of money he econo stration: 1 ag te etait cm at reseeve voductory Macroeconomics 72 20. 2. 2. 2, 2. 2. Assuming CRR = 2% - ke dpeso Implying that commercial banks can create credit 80 times oftheir cash reserves with the Rl Incase, ARs ased 104%, k 5 Iimpving tat credit creation power ofthe commercial banks is reduced to half. e woud lead to 3 significant cut money supp in the economy) Define ‘money maltner’ lease 2019 (58/2/00 [Page 154) Distinguish between “Qualitative and Quanttatve tok of credit ontrol as may be used bya Central Bank [case 2019 (58/2/1) [Page 157-a51 Discuss brefy the fllawing functions of a Cetra Bank: (i Bankers bank (i Lender af at resort. lease 2019 (58/2/2) (Pape 255] Discuss brety the “credit controler” function of @ Central Bank [case 2019 (59/2/3)] [Page 156-161) ‘According toa report forwarded by the Reserve Bank af India, there was 2 fallin rate of ination 35 ‘measured by Consumer Price Index (CPI) on year-on-year basis to 5% fam B%in the prvious year. Which af the flowing statements represents the station? (critter (th tonal aT ether (iene i (cose 2.9609) Ee he procs f money creation by 2 commer bak ig ptt ut saree ese 0 a0) or Dias ry he ct creation procs he baking t,he aera sole ese 509) (apes) Sate tel lyehy te cena teers (CBS0:9 (58/4 ages) ee — Bio confines coe 09 ceaah tae 12,019 a rr————_=™s ceo power oe bangs, estan Soran t i = ig crete tl Asin c= 1% : sori, kedes Implying that commercial banks (banking ster inthe county) can create crit upto? times of thar cash eserves with the Rl sarkng 173 — Incase, CRR cut 102%, 7 Ap 50 Iralyng that ret creation power athe comm rise nthe supply of money nthe econo’) Jue of money multiplier would be 29, iflegal reserve ratio is 20% the val [choose the correct alternative] az ws fas aa tel (ase 2019 (58/5/89) 30, What are primary deposits? (Page 1531 4. explain the flowing fonction ofthe Central Bank (i) Banker's bank (case 2019 (58/5/1H) {i Authorty of eurency ss. {Page 154,155] 432, Explain the folawing functions of the Centra Bank: {0 Lender of as resort (i) Banker ta the Government (cose 2019 (58/57) IPage155] sas gh Enlen how ung “Bank Rate” the Cerra Bank an reuse money UPPY 2 ove case 2019 (58 {b) what is mast by "Repo Rate"? {Page 257,158) 6. NCERT Questions (With Hints to Answers) 1. What are the instruments of monetary policy of RBI? {hn nseurents of monetary pocy of fare broadly classifies 2 Me) ontative Instruments: () Bark Rae, () Repo Rate (i) Reverse eps Ete {Cah Reserve Ri), (SUR [Statutory Lauiy Rat, {by cualtatve instruments: () Margin requirement, i) atoning 2. Do ou cansider a cornmeal bank ‘

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