Definition of Money

• “Anything which is widely accepted in payments for goods or in discharge

of other kinds of business obligations.”

Or

• Anything that is generally acceptable as a means of exchange and that at

the same time acts as a measure and a store of value.

Or

• Any financial asset which could be readily exchanged for goods.

 Money serves three functions in our
economy.
a. Definition of medium of exchange: an item that buyers give to sellers
when they want to purchase goods and services.

b. Definition of unit of account: the yardstick people use to fix prices or

record earnings. Rs. 10 is exactly 10 times of Rs. 1.

c. Definition of store of value: an item that people can use to transfer

purchasing-power from the present to the future.
 Ideal Money should be ->
• Durable
• Portable
• Divisible
• Uniform quality
• Low opportunity cost
• Stable value
Evolution of Currency : Coins and
Bank Notes
• India has been one of the earliest issuers of
coins in the world (circa 6th Century BC) but
notes issue stated in late 18th century.
• https://rbi.org.in/Scripts/ic_museum.aspx
 Notice the difference :
Note: Read Coinage act of 2011 and 1940
https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/COIN281114.pdf
 Basic Difference
• One rupee note has got the status of coin(coin
picture on note) but other denomination notes
are notes only
• One rupee note, like coins, is an asset but
others are a part of Liability
• One rupee note along with coins are printed by
GOI but other are done by RBI- seal is there
• “I promise to pay” is not mentioned on one
rupee note but its mentioned on other notes
• One rupee note is signed by Finance Secretary
but other notes are signed by RBI governor.
 Types of Money
• Barter
• Commodity money
• Bimetalism
• Silver coins
• Gold coins
• Gold representing coins
• Fiat Money / representative money/ token
money
• Cheque
 RBI – Central Bank of India
• The Reserve Bank of India was set up on the basis of the
recommendations of the Hilton Young Commission. The
Reserve Bank of India commenced operations on April 1,
1935. In 1949 it nationalized. GOI bought maximum shares
and became the owner of RBI
• The Reserve Bank of India has four zonal offices at Chennai,
Delhi, Kolkata and Mumbai. It has 19 regional offices and 10
sub-offices.
• Subsidiaries: National Housing Bank (NHB)1988, Bharatiya
Reserve Bank Note Mudran Private Limited
(BRBNMPL)1995, National Bank for Agriculture and Rural
Development (NABARD)1982, Deposit Insurance and Credit
Guarantee Corporation (DICGC) 1978.
 Functions of RBI
1. Issue of Bank Notes

2. Banker to Government

3. Custodian of Cash Reserves of Commercial Banks

4. Custodian of Country’s Foreign Currency Reserves

5. Lender of Last Resort

6. Central Clearance and Accounts Settlement

7. Controller of Credit
 RESERVE BANK OF INDIA BALANCE SHEET AS ON JUNE 30, 2018
(Amount in ₹ billion)
Liabilities Schedule 2016-17 2017-18 Assets Schedule 2016-17 2017-18
Assets of Banking Department
Capital   0.05 0.05      
(BD)
Reserve Fund   65.00 65.00Notes, Rupee Coin, Small Coin 5 0.12 0.09
Other Reserves 1 2.26 2.28Gold Coin and Bullion 6 627.02 696.74
Deposits 2 8,963.48 6,525.97Investments-Foreign-BD 7 9,319.94 7,983.89
Other Liabilities and
3 8,946.84 10,463.04Investments-Domestic-BD 8 7,557.50 6,297.45
Provisions
       Bills Purchased and Discounted   0.00 0.00
       Loans and Advances 9 172.56 1,638.55
       Investment in Subsidiaries 10 33.70 33.70
       Other Assets 11 266.79 405.92
Liabilities of Issue Department      Assets of Issue Department (ID)      
Gold Coin and Bullion (as backing
Notes issued 4 15,063.31 19,119.60 6 690.30 743.49
for Note issue)
       Rupee Coin   6.12 9.26
       Investments-Foreign-ID 7 14,366.89 18,366.85
       Investments-Domestic-ID 8 0.00 0.00
Domestic Bills of Exchange and
          0.00 0.00
other Commercial Papers
Total Liabilities 33,040.94 36,175.94Total Assets 33,040.94 36,175.94
Flow variable:

A variable that measures something over an interval of time,

such as your income per month, GDP etc.

Stock Variable:

A variable that measures something at a particular point of

time, such as your assets as of now, country’s money supply
by the end of 2018 etc.
 Money Supply
• Definition of Money Supply:
It refers to the amount of money which is in circulation in an
economy at any given time.

• Money supply plays a crucial role in the determination of price level and
interest rates.

• Growth of money supply helps in acceleration of Economic development and

price stability.

• There must be a controlled expansion of money supply i.e

No inflation or Deflation in the Economy.
 Concept
• It is the total stock of money held by the people ( household, firms and
institutions)

• It the total sum of money available to the public in the economy at a point
of time

• The separation of producers of money from the users of money is

important from the viewpoint of both Monetary theory and policy

• Narrow definition of money supply is M = currency + demand deposits

 Determinants of Money Supply
• M= Cp + D

• The two important determinant of Money supply are

– Reserve Money or Amount of High Powered Money

– Size of Money Multiplier

To understand money multiplier theory let us understand High-power

money
 Concept of H
• High Powered Money OR monetary base
– Produced by the govt. & central bank & held in the hands of
public or bank, denoted as “H”
– H= C+R
Where C is currency with the public & R is cash reserves held by
Banks.
Note: a fraction of deposits are given as loan to generate interest &
the rest is kept as reserve with the bank so that all the demands are
liquidated

• RBI and Government are producers of high- powered money and Banks are
producers of demand deposits.
• For producing demand deposits or credit, banks have to keep with themselves cash
reserves of currency.
• As cash reserves leads to multiple creation of DD and larger expansion of
money supply.
The money multiplier is a key element of the fractional
banking system.

1. There is an initial increase in bank deposits (monetary

base)
2. The bank holds a fraction of this deposit in reserves and
then lends out the rest.
3. This bank loan will, in turn, be re-deposited in banks
allowing a further increase in bank lending and a further
increase in the money supply.
Money Multiplier (with initial deposit 100 & Reserve ratio 20%)

Period Deposit Loan Reserve Money supply

1 100 80.0 20 100
2 80.0 64.0 16.0 180.0
3 64.0 51.2 12.8 244.0
4 51.2 41.0 10.2 295.2
5 41.0 32.8 8.2 336.2
6 32.8 26.2 6.6 368.9
7 26.2 21.0 5.2 395.1
8 21.0 16.8 4.2 416.1
9 16.8 13.4 3.4 432.9
10 13.4 10.7 2.7 446.3
11 10.7 8.6 2.1 457.1
. . . . .
. . . . .
. . . . .
Total 457.1      
Money Multiplier (with initial deposit 100 & Reserve ratio 20%)
To summarize:

• Money multiplier (also known as monetary multiplier)

represents the maximum extent to which the money
supply is affected by any change in the amount of
deposits. It is ratio of increase or decrease in money
supply to the corresponding increase and decrease in
deposits.
• Assume that there is no excess reserve & people don’t
keep cash/currency in hand then with the reserve ratio of
20 percent ie 1/5, the money multiplier, m, will be
calculated as:
• m= 1/ (1/5)
• m= 5
 What if…
If borrowers do keep a fraction of loans received
in cash

What will happen to the multiplier?

 Money Multiplier -m
• It is the degree to which money supply is expanded as a result of the
increase in high powered money.

– M= H.m

– Money supply will increase:

1. When the supply of high – pwered money H increases

2. When currency- deposit ratio of public decreses
3. CRR ratio falls
 Money multiplier: It can be measured as:
m= (1+c)/(c+r), where, c is currency-deposit ratio
and r is reserve requirement ratio .
How does that look like for India?
Sl.
Measure India US Europe
No

Money Multiplier
 1. (31st October 5.8 3.01 6.61
2015)
Money Multiplier
 2. (31st January 4.6 8.38 11.15
2002)

http://www.thehindubusinessline.com/portfolio/reserve-ratios-and-the-money-
multiplier-effect/article3562983.ece
 Measurement of Money supply
M1 (Narrow Money)
M1= C +D
C= Currency with the Public
D = demand deposit with banks AND other deposits with RBI
Money Supply M2
M2= M1 + Saving deposit with the post office saving banks
The small saving deposits are not as liquid as demand deposits
but are more liquid than the time deposits.
M3 / Broad Money
M3 = M1 + Time Deposits with the banks
Time deposits are nit as liquid however loans from the banks can be
obtained against them and they can also be withdrawn any time by
forgoing interest earned on them.
Money Supply M4
M4 = M3 + Total post office deposits (TPOD)
 Statement on Money Supply
(₹ billion)
Outstanding as on Variations over
Financial year so far Year-on-year
Item 2018 2019 Fortnight
2017-18 2018-19 February 2, 2018 February 1, 2019
Mar 31 Feb 01 Amount % Amount % Amount % Amount % Amount %
1 2 3 4 5 6 7 8 9 10 11 12 13
M3 139625.9 148946.8 1358.9 0.9 7044.5 5.5 9321.0 6.7 12478.5 10.2 13982.9 10.4
                         
Components (i+ii+iii+iv)                        
i) Currency with the Public 17597.1 19842.0 -25.4 -0.1 4043.8 32.0 2244.9 12.8 6869.5 70.0 3157.0 18.9
                         
ii) Demand Deposits with Banks 14837.1 13573.4 273.6 2.1 -1440.6 -10.3 -1263.7 -8.5 761.5 6.5 1046.6 8.4
iii) Time Deposits with Banks 106952.6 115266.0 1103.8 1.0 4441.6 4.4 8313.5 7.8 4792.9 4.8 9724.6 9.2
                         
iv) `Other ' Deposits with Reserve Bank 239.1 265.4 6.9 2.7 -0.3 -0.2 26.3 11.0 54.6 35.0 54.8 26.0
Sources (i+ii+iii+iv-v)                        
i) Net Bank Credit to Government 40014.0 44623.8 295.0 0.7 2015.7 5.2 4609.8 11.5 0.5 0.0 4042.0 10.0
Sector (a+b)
                         
a) Reserve Bank 4759.6 8988.3 347.7 - -1800.7 - 4228.7 - 578.7 - 4580.9 
b) Other Banks 35254.4 35635.5 -52.7 -0.1 3816.4 11.8 381.1 1.1 -578.2 -1.6 -538.9 -1.5
                         
ii) Bank Credit to Commercial Sector 92137.2 100285.5 997.1 1.0 3981.6 4.7 8148.3 8.8 8044.0 10.0 12188.9 13.8
(a+b)
                         
a) Reserve Bank 140.3 82.5 0.0  0.6  -57.8  24.1  9.0 
b) Other Banks 91996.9 100203.0 997.1 1.0 3981.1 4.7 8206.1 8.9 8019.9 10.0 12179.9 13.8
                         
iii) Net Foreign Exchange Assets of 29223.0 29782.4 303.3 1.0 2778.6 10.9 559.5 1.9 2929.5 11.5 1421.5 5.0
Banking Sector
                         
iv) Government's Currency Liabilities to
the Public 256.5 258.0 - - 5.4 2.1 1.5 0.6 8.1 3.3 1.8 0.7
                         
v) Banking Sector's Net Non-Monetary 22004.8 26002.8 236.4 0.9 1736.8 8.4 3998.1 18.2 -1496.4 -6.3 3671.2 16.4
Liabilities
                         
of which : Net Non-Monetary 9069.9 11495.3 219.3 1.9 476.3 5.7 2425.4 26.7 -566.7 -6.0 2685.5 30.5
Liabilities of R.B.I.
 No. 6: Money Stock Measures
(₹ Billion)
Outstanding as on March 31/last reporting Fridays of the month/reporting Fridays
2015 2016
Item 2015-16
Sep. 18 Aug. 19 Sep. 16 Sep. 30
1 2 3 4 5
1 Currency with the Public (1.1 + 1.2 + 1.3 – 1.4) 15,972.5 14,340.4 16,732.2 16,882.1 16,556.9
1.1 Notes in Circulation 16,415.6 14,792.2 17,219.5 17,376.0 17,046.1
1.2 Circulation of Rupee Coin 211.6 199.1 222.3 222.3 225.3
1.3 Circulation of Small Coins 7.4 7.4 7.4 7.4 7.4
1.4 Cash on Hand with Banks 662.1 658.3 717.0 723.5 721.9
2 Deposit Money of the Public 10,052.8 9,150.5 10,199.0 10,635.9 11,863.3
2.1 Demand Deposits with Banks 9,898.3 8,995.4 10,059.0 10,491.9 11,677.3
2.2 ‘Other’ Deposits with Reserve Bank 154.5 155.1 140.0 144.0 186.0
3 M1 (1 + 2) 26,025.4 23,490.9 26,931.2 27,518.1 28,420.2
4 Post Office Saving Bank Deposits 615.7 523.5 707.6 707.6 714.2
5 M2 (3 + 4) 26,641.1 24,014.5 27,638.8 28,225.7 29,134.5
6 Time Deposits with Banks 90,150.8 86,412.3 94,295.5 94,508.4 97,533.7
7 M3 (3 + 6) 116,176.2 109,903.2 121,226.7 122,026.5 125,954.0
8 Total Post Office Deposits 2,084.1 1,874.0 2,237.4 2,237.4 2,256.7
9 M4 (7 + 8) 118,260.3 111,777.2 123,464.2 124,263.9 128,210.6
Note: For scheduled banks, March-end data pertain to the last reporting Friday.
2.2: Exclude balances held in IMF Account No.1, RBI employees’ provident fund, pension fund, gratuity and superannuation fund.

https://m.rbi.org.in/Scripts/PublicationsView.aspx?id=9455
 Quantity Theory of Money: -
Fisher’s Transactions Approach
• Money as a means of buying goods and services. Amount of money people
have to hold to undertake a given volume of transaction over a period of
time . MV= PT Where, M= Amount of money
T= The volume of Transaction
P= Average price level per unit of
transaction
V= Velocity of circulation of money
That shows a direct relationship between the quantity of money in an
economy and the level of prices of goods and services sold.
According to QTM, if the amount of money in an economy doubles,
price levels also double, causing inflation. In order to curb inflation,
money growth must fall below growth in economic output.
 Demand of Money

• It’s the willingness to hold on demand funds that could be

used readily

• Medium of Exchange
• Store of Value
• An unit of account
(Already discussed before)
 Keynes theory of
Liquidity Preference
• Liquidity preference means the demand for money to hold cash. An
investor demands a higher interest rate, or premium, on securities with
long-term maturities, which carry greater risk, because all other factors
being equal, investors prefer cash or other highly liquid holdings.
• Investments that are more liquid are easier to sell fast for full value.
• According to the liquidity preference theory, interest rates on short-term
securities are lower because investors are sacrificing less liquidity than
they do by investing in medium-term or long-term securities.

• The desire for liquidity arises because of three motives

– Transaction motive
– Precautionary motive
– Speculative motive
a) Transaction Motive:
- Demand for money for the current transactions of individuals
and business firms.
- Individuals hold cash in order to bridge the interval
between the receipt of income and its expenditure.

b) Precautionary Motive:
- Desire for people to hold cash balances for unforeseen
contingencies (Unemployment, sickness, accidents….) .
- It depends upon the psychology of individual and the
conditions in which he lives.

“The money held in both the motives are mainly the function of
the size of Income but NOT rate of interest”
c) Speculative Demand for money (Portfolio theory)
• Desire to hold ones resources in liquid form in order to take advantage of
the market movements regarding the future changes in the rate of interest

• The cash is used to make speculative gains by dealing in bonds whose

prices fluctuate i.e Less money will be held under speculative motive at a
higher current rate of interest, More money will be held under this motive
at a lower current rate of interest.

• Thus demand for money under speculative motive is a function of rate of

interest
 Demand for money
• Transaction & precautionary demand is highly inelastic to interest rate but
speculative demand is elastic to money supply

Rate
Of
interest
TD PD SD

Demand for money

 Liquidity Trap

• Keynes visualised conditions in which the speculative demand for money would
be highly or even totally elastic so that changes in the quantity of money would
be fully absorbed into speculative balances.
• Higher the rate of interest lower the demand for money for speculative motive
and less money would be kept as inactive balance and vice versa.

• The LP curve becomes Rate Liquidity Trap

perfectly elastic at Of
interest
very low rate of interest LP

Speculative Demand
 Liquidity Trap

• i.e it indicates a absolute liquidity prefrences of the people.

• At low rate of interest people will hold money as inactive balance which is called
as a liquidity trap.

• The expansion of money supply gets trapped and cannot effect rate of interest and
the level of investment.

• However demand of money does not depend so much upon the current rate of
interest as on expectations about changes in the rate on interest
 Equilibrium
• Money market equilibrium occurs at the
interest rate at which the quantity of money
demanded equals the quantity of money
supplied. All other things unchanged, a shift in
money demand or supply will lead to a change
in the equilibrium interest rate. Money supply
is given as constant at one period of time and
so as the real money supply (adjusting for
inflation) too which is represented by M/P.
Equilibrium in Money Market
 Problem to solve :Money Market
Equilibrium
Q: If, M=Rs.150, & L=0.20Y-4i, then find out
the money market equilibrium.
Ans: As we saw above, Money market will be in
equilibrium when Money demand= Money
supply. So the equilibrium condition would be
Rs.150=0.20Y-4i
Þ .2Y= 150+4i
Þ Y = 750+20i , It is also called as LM equation
 The Goods Market Equilibrium
Whatever is earned, its either consumed or saved by the economy. So Y= C+S
Again the total expenditure approach says that Y=C+I+G+(X-M)
In the equilibrium condition, when income is equal to planned expenditure,

Y= C+I+G+(X-M)
FOR Example: C=100+0.80Y, I=140-6i, G= 10, X-M=-20,
Then goods market Equilibrium condition will be
Y= 50+0.80Y+140-6i+ 10-20
.2Y= 180-6i
Y= 900 – 30i, this is called the IS function.

(Why? Because when G=0 and X-M= 0, C+I=C+S, So I = S, or Investment = Saving)

The Equilibrium of Both the markets: The production of
real output matches with required amount of money
needed for transaction
 The Equilibrium of Both the
markets
Y = 750+20i , LM equation
Y= 900 – 30i, IS function.
750+20i= 900 – 30i
Þ 50i= 150
Þ i= 3
Þ Y= 750+20*3= 810
Therefore economy will have an equilibrium
when at 3% interest rate and Rs. 810 of real
output or Income.