Week#3

Paper Money
1. Definition of money

2. Kinds of paper money

3. Advantage and disadvantage of paper money

 Paper Money

Definition

Paper money refers to bank notes issued by

the central bank of the country.

Paper Money is generally accepted in daily

transactions as a medium of exchange.
 Paper Money
• China is the originator of paper money in 9th century when
Hsien-tsung was the emperor.
• The purpose of paper money was the overcoming the
difficulties of supplying the precious metal.
• In 17th century convertible paper money was issued on large
scale by institution in advance country.
• Inconvertible paper currency was issued during 18th century.
• Now in all developed and under develop countries of world
inconvertible money is used as medium of exchange.
 Kinds of Paper Money
Paper money is classified in following three kinds.
1. Representative paper money
2. Convertible paper money
3. Inconvertible fiat paper money
 Representative Paper Money
The representative paper money is that money which
has hundred percent metallic reserves behind it.
• The government keeps such reserves for the holders of
paper money when they demand it.
• The example of representative paper money is
American gold and silver certificates, which are
guaranteed gold and silver deposits in treasury.
 Convertible Paper Money
Convertible paper money is that money which carries a
promise by the issuer that the paper can be converted
into the standard money metal at some future date.
• The convertible paper money can be exchanged for full
bodied money upon demand of the holder of money.

• The government does not maintain hundred percent

reserves against such money.
 Convertible Paper Money
• The convertible paper money is issued against gold,
silver and securities.
• The government cannot maintain hundred percent
reserves for issuing money but it is convertible into
gold, silver of full-bodies coins.
 Inconvertible Fiat Paper Money
Paper money that cannot be exchanged for full-bodied
money or standard money at the option of holder.
• The issue of inconvertible paper money is regulated by
the law of the state.
• The gold or silver reserves are not kept by the monetary
authority.
• The money is issued on the written promise of the
government.
Inconvertible Fiat Paper Money
• Issuing authority should keep a certain percentage of
standard money metal against the note issue.
• In paper money there is danger of over issue whenever
government expenditure increase from its income.
• Germany over issued its currency in the first and second
world war.
• Inconvertible paper money is also called fiat money.
 Paper money advantages
1. Economical:
• Paper money is economical because central bank is not
require to keep metal for its issuing.
• Cost of paper money is also very small
2. Ease of money supply
• As money is not back by gold therefore monitory
authority easily manage supply of money according to
the requirement of trade.
 Paper money advantages
3. Promote economic growth
• In paper money government regulate money supply in
such a way that productive resource of country are fully
utilize and greater economic growth achieved.
4. Internal price stability
• Monitory authority can maintain internal price stable by
implementing expansion or contraction in money
supply according to the economic condition.
 Paper money advantages
5. Helpful in emergency
• Paper money is very useful in time of war when huge
funds are needed to finance it.
• It also help in meeting financial crisis by expanding or
contracting money supply.
6. Regulation of exchange rate
• Paper money is use as an effective and automatic
regulator of exchange rate between the countries.
 Paper money advantages
7. Uniform quality
• Paper money has uniform quality therefore holder face
no problem during the purchasing.
 Paper money Disadvantages
1. Danger of inflation:
• In paper money there is danger of inflation due to
increase in money supply.
• Government over issue paper currency for covering
deficit financing which cause inflation .
• Deficit financing is practice in which a government
spends more money than its revenue, the difference
being made up by borrowing or issuing more note.
 Paper money Disadvantages
2. Internal price instability
• No price stability in real situation due to changing value of
currency.
3. Exchange instability
• In paper money standard there is also wide fluctuation in
foreign exchange rate due to economic instability.
4. Danger of mismanagement
• Mismanagement occur if monitory authority does not issue
notes as required which cause inflation or deflation.
 Paper money Disadvantages
5. Fear of Demonetization
• Withdrawal of a particular form of currency from circulation
is called demonetization.
• Paper currency have no intrinsic value if government order
the demonetization of currency the paper note give up value
and if holder doest not submit it on time it become useless.
6. Use within the country
• As paper currency have no intrinsic value therefore it is only
use in issuing country, outside country it has no value.