asgmt mfi | Reserve Bank Of India | Money Supply

RESERVE BANK OF INDIA:The Reserve Bank of India is the central banking institution of India and controls the

monetary policy of the rupee as well as US$300.21 billion (2010) of currency reserves. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934 and plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union. The present monetary system of India is managed by the RBI which is the central bank of country. The Indian monetary system is based on inconvertible paper currency. For internal purposes there are rupee and coins and currency notes. For external purposes the rupee is convertible into other currencies of world. The printing of currency notes is the monopoly of RBI which is owned and managed by the government of India. The RBI can print and issue currency notes of different denominations from two rupee notes to 10,000 rupees notes. The RBI maintains a separate issue department to manage the issue of currency notes. This department maintains reserves or assets against the issue of currency notes. At one time the assets of the issue department consisted of two parts. a) At least 40% of total assets would consist of gold coins, gold bullion or sterling securities of which the gold part should at least be Rs. 40 Crores in value and b) 60% of assets would be in rupee coins, rupee securities of the government of India, eligible bills of exchange or promissory notes payable in India These provisions known originally as the proportional system- were modified many times and at present the asset of issue department consists of minimum of gold and foreign securities to the extent of Rs. 200 Crores and balance in rupee securities. On what bases RBI print currency:The Reserve Bank estimates the demand for bank notes on the basis of the growth rate of the economy, the replacement demand and reserve requirements by using statistical models. The Reserve Bank decides upon the volume and value of bank notes to be printed. The quantum of bank notes that needs to be printed broadly depends on the annual increase in bank notes required for circulation purposes, replacement of soiled notes and reserve requirements.

As a result. intermediate products. the Reserve Bank has authorized selected branches of banks to establish currency chests. The Government. To facilitate the distribution of notes and rupee coins. factors of production etc. automobiles. Along with the general increase in prices. making foreign goods more expensive and domestic goods cheaper. At present. More buyers with less production and supply of the various demanded items lead to steep increase in prices. this causes foreign materials and goods to become more expensive for customers. Competitive position of firms eroded. It is because the people have more money in hand and jump to buy the goods of their interest. An increase in money supply can also have negative effects on the economy. The Reserve Bank estimates the quantity of notes that are likely to be needed denomination-wise. and places the indent with the various presses through the Government of India. With the complex global economy. prices of raw materials. Product price . Firms may declare lower dividends (for a given level of profit). there are over 4368 currency chests. Some examples may include steel. The Reserve Bank also co-ordinates with the Government in the designing of bank notes. This is the root cause for inflation. decides on the various denominations. it creates a demand for various commodities. It causes the value of rupee to decrease making foreign goods more expensive and domestic goods cheaper. on the advice of the Reserve Bank. the purchasing power of the domestic currency goes down. The currency chest branches are expected to distribute notes and rupee coins to other bank branches in their area of operation. The notes received from the presses are issued and a reserve stock maintained. It causes the value of the rupee to decrease. Notes fit for circulation are reissued and the others (soiled and mutilated) are destroyed so as to maintain the quality of notes in circulation. An increase in money supply can also have negative effects on the economy. It causes inflation. Notes received from banks and currency chests are examined. These are actually storehouses where bank notes and rupee coins are stocked on behalf of the Reserve Bank.The Reserve Bank of India (RBI) manages currency in India.  Inflation:If notes are printed and pumped into the circulation. capital goods. including the security feature. What happen if RBI prints unlimited currency? When the government print unlimited currency its result to increase money supply. and building materials. also go up rising capital goods prices would necessitate larger retained earnings by business.

When quantity of money decrease price level decrease but value of money increase. Other macro variables affected are rate of interest.increases become inevitable which may lead to decline in demand (Depends On price elasticity of demand for the product). This has the effect of increasing consumer spending because money is easier to borrow. When banks have more money to loan. There is direct and proportional relation between quantity of money and price level. Y P2 G F (A) N Price Level P1 P O M M1 M2 E X Y 1/P A Value of Money 1/P1 1/P2 O M M1 B (B) C X M2 Quantity of Money . When quantity of money increase price level increase but value of money falls. exports. they reduce the interest rates consumers pay for loans. This will normally spur additional spending by consumers and build confidence in the economy because it is easier to obtain money. exchange rate (of currencies) & future expectations. The government will request an increase in money supply when the economy begins to slow.

In Fig (A) quantity of money is shown on OX-axis and price level on OY-axis. Curve VV which is formed by joining points A.Suppose economy produces 1.and OM2 . C expresses proportionate relation between quantity of money and its value and this relation is inverse. and building materials. and the value of money has increased eg. The price of the 1000 unit will increase to $ 15.000.000 but the output of the economy stays at 1000 units. . Therefore if the money supply is increases but the output stays the same everything will just become more expensive. Then inflation will be roughly increases 2%. the price level is OP. Some examples may include steel. value of money 1/P is shown on OY-axis. People are not better off. If output increased by 5% and money supply increases by 7%. Suppose that the government print an extra $5000 notes creating a total money supply of $15. ON line which is formed by joining points EFG expresses proportionate relation between quantity of money and price level and this relation is direct. A $10 note buys less goods than previously.  Money supply also effect the foreign exchange rate:An increase in money supply can also have negative effects on the economy. domestic goods are relatively costlier and foreign goods are .With the quantity of money going upto OM2 the corresponding price level move upto OP2 . the price level also increases in the same proportion to OP1. When the quantity of money is OM. Effectively people have more cash but the number of goods is the same because people have more cash. the value of money falls to 1/P1 and 1/P2 respectively . It causes the value of the rupee to decrease. the price level also decreases in same proportion. They are willing to spend more to but goods in economy. When the quantity of money decreases.000 units of output suppose money supply $10. If there is inflation in the domestic country that is price level in the home country is more than price level in the foreign currency. In Fig (B). The price has increased but the quantity of output stays the same. When the quantity of money is OM. With the complex global economy. As the quantity of money increases to OM1 . this causes foreign materials and goods to become more expensive for customers. automobiles. the value of money is 1/P. For example: . making foreign goods more expensive and domestic goods cheaper. When the quantity of money increase to OM1. B. This means that the average price of output produced will be $10.

The new exchange rate is OR1 which is less than the initial exchange rate OR. . Consequently. Y S S1 Exchange Rate R R1 E E1 D D1 X O Q Quantity of Domestic Currency Diagrammatically. Conclusion:Therefore at last we can say that government cannot printing unlimited currency because it lead to inflation which further leads to depreciation of domestic currency. It implies depreciation of domestic currency. supply curve of domestic currency shifts to the right and demand curve for the domestic currency shifts to the left.relatively cheaper. It results in lower exchange rate which means depreciation of domestic currency. The equilibrium is at E1 . As a result foreign demand for domestic currency decreases and supply of domestic currency increases. increases in the price level in the domestic economy shifts the demand curve for domestic currency to the left from D to D1 and the supply curve to the right from S to S1 .

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