MONEY

Meaning of Money
• Money (money supply)—anything that is generally
accepted in payment for goods or services or in
the repayment of debts; a stock concept. Money
supply is the total amount of money available in
the economy. (stock)
• Wealth—the total collection of pieces of property
that serve to store value (stock)
• Income—flow of earnings per unit
of time (flow)

2
 Functions of Money
• Medium of Exchange—promotes economic
efficiency by minimizing the time spent in
exchanging goods and services.

• A good medium of exchange

– Must be easily standardized
– Must be widely accepted
– Must be easy to carry
– Must not deteriorate quickly

3
• Unit of Account—used to measure value in
the economy: assets, goods, services.

• Store of Value—used to save purchasing

power; allows inter-temporal substitution of
income

– most liquid of all assets but High inflation

diminishes its “store of value” function.
• Money Supply – Total volume of money that is circulated in the
economy.
– M1–
– Currency in Circulation

– Demand Deposits of public with banks

– M 2 – Total of M 1 + Post Office savings + Time Deposits of

small denominations

– (M1 & M2 = Narrow Money)

• M 3 – Total of M 2 + Large time deposits +
Institutional funds.

• M 4 - All deposits with post office saving(excluding

National Savings Certificates).

(M3 & M4 = Broad Money )

These gradations are in decreasing order of liquidity. M1 is

most liquid and easiest for transactions

M4 is least liquid of all. M3 is the most commonly used

measure of money supply
More money = more liquidity = easy to get loans = inflation

central bank money (physical currency, government money)

commercial bank money (money created through loans) -

sometimes referred to as private money.

Expansion of Money :

i. Money is pumped into market through issuing of Currency by

RBI.

ii. Borrowings of Government.

iii. Government meets its budgetary deficits by borrowing from RBI

• Contraction of Money :
– Unlimited expansion of money and credit would lead to ?

Role of RBI
Monetary Policy: It is a statement stated bi-annually through
RBI.

Fixed by considering the prevailing prices and growth

patterns of economy and also rate of population growth
and employment.
The Reserve Bank estimates the demand for banknotes on
the basis of the growth rate of the economy, the
replacement demand, Inflation and public expenditure
demand by using statistical models/techniques. 

All the currency issued is the monetary liability of RBI.

Backed by assets of equal value held.

Assets consist of gold, foreign securities, and the

government’s securities.
 Monitory Policy
• Expansionary policy, increases the total
supply of money in the economy rapidly
OR
• Contractionary policy, decreases the total
money supply or increases it only slowly.
• It Regulates the supply of money and the cost of availability of credit
in the economy.

• Aims at – maintaining price stability and Economic growth through;

– Changing money supply and interest rates.

– Credit Control Measures :

– Bank Rates: Rate at which the central bank provides credit to

commercial banks.
• Increase in bank rates leads to ?

– Increase in lending rate

– Money supply could be checked.
– Acts as a pace setter to all other rates of interests.
– Increase in Bank rates could lead to reduction in
• Borrowings
• Level of inventory holding
• Investment
• Prices
– CRR (Cash Reserve Ratio): Every Bank has to keep certain
amount of cash reserve with the RBI.

– Total of their demand and time liabilities

– RBI uses CRR either to drain excess liquidity or to release

funds needed for the growth of the economy from time to
time.

– Increase in CRR means that banks have less funds available

and money is sucked out of circulation.
• This serves duel purposes i.e.

– (a)  ensures that a portion of bank deposits is kept

with RBI and is totally risk-free,

– (b) enables RBI to  control liquidity in the system,

and thereby, inflation by tying the  hands of the
banks in lending money.
– SLR (Statutory Liquidity Ratio) : Every bank should keep
certain percentage of its total demand and time deposits
with RBI in the form of Liquid assets,
at the close of business every day.
– The assets are cash, precious metals, or certificates that
a bank keeps with them as a reserve.
– SLR controls the credit growth in the economy and limits
the influence banks have in putting more money into the
economy.
 – Intended to make banks invest in government securities
while

– CRR is intended to maintain the purchasing power of

money in order to curb inflation.

• Repo Rate signifies the rate at which liquidity is injected in

the banking system by RBI.

– Repo rate: Interest rate at which the Reserve Bank of India

lends money to other banks.
– It is a repurchase agreement between RBI &
commercial bank.  (Essentially short term
securities). 

– Purchased or sold at discounted rates.

• When the repo rate increases borrowing from
RBI becomes more expensive.

• If RBI wants to make it more expensive for the

banks to borrow money, it increases the repo
rate;

• Similarly, if it wants to make it cheaper for banks

to borrow money, it reduces the repo rate
• Reverse Repo rate :  rate at which banks park their short-term
excess liquidity with the RBI. 

• The RBI uses this tool when it feels there is too much money
floating in the banking system.  

• An increase in the reverse repo rate  means that the RBI will
borrow money from the banks at a higher rate  of interest. 

• As a result, banks would prefer to keep their money with the RBI.

• Whereas Reverse repo rate signifies the rate at which the central
bank absorbs liquidity from the banks. 
• Open Market Operations: buying or selling of bonds by RBI in the
open market.
• The assets purchased or sold are –
– Government Securities / Bonds
– Company Shares
– Foreign Exchange
 Fiscal Policy
• Is a deliberate attempt of the government to
influence the economy by changing levels of
government expenditure and / or taxation.

• Government must provide equitable

Division of revenue raised nationally
among :
– Centre, state and local
• It should be of national interest.
• Consider economic disparity among the states.
• Budgets must contain:
– Estimates of revenue and expenditure; differentiating
between capital and current expenditure.
– Proposal for financing and anticipated deficit for the said
period.
– Funding areas could be :
• Agriculture, Education, Health, Social Security, Institutional,
 Revenue

Deficit Fiscal Factors Expenditure

Output and Employment

➢ Fiscal deficit can be higher if …

➢ … public investment is large.

    Tools of Fiscal Policy
 

(1)Government Expenditure: Chosen area

(2)Taxes, both direct & indirect: Revenue generation

(3)Deficit financing: Government spends more money than it

receives as revenue, the difference being made up by borrowing

issue bonds or to print money

(4)Subsidies: they can alter relative prices and budget

constraints and thereby affect decisions concerning production,
consumption and allocation of resources.
Subsidies, lead to changes in demand/ supply decisions. ..

By means of creating a wedge between consumer prices

and producer costs, Subsidies are often aimed at :

• inducing higher consumption/ production

• offsetting market imperfections

• achievement of social policy objectives including

redistribution of income, population control, etc
(5)Transfer payments: Transfer payments are
payments made by the government sector to the
household sector with no expectations of productive
activity in return.

The three common transfer payments are:

• Social Security benefits to the elderly and disable,

•unemployment compensation to the unemployed,

•welfare to the poor.j