Macro Economics

Chapter 6

Institution of Money & Modern Economics

Topics Covered
• • • • Nature, role and Function of money. Money and Credit. Banking system Working of monetary and credit policy in India.

What Is Money?
• Money is the medium of exchange. • Money is anything that serves as a commonly accepted medium of exchange or means of payment. • The earliest kind of money were commodities, but over time money evolved into paper currencies, bank money.

• Money avoids the need for a double coincidence of wants and thus facilitates a wider range of transaction.Nature of Money • Money is a medium of exchange. and a store of value. . a unit of account.

Kinds of money • • • • • Coins such as gold. silver. cattle etc. Paper notes. Fiat money. Credit money or deposits with Banks. Commodity money in the form of grains. . copper coins.

I want cloths • “BARTER SYSTEM” .• “DOUBLE COINCIDENCE OF WANTS” I’ll give you shoes for your Wheat I don’t need shoes .

Money’s Function • There are the three basic money’s function: – Medium of exchange – Standard of value – Store of value .

Q M: money supply V: velocity of circulation of money P: the average price level Q: the total output .V=P.The Quantity Theory of Money • Economists use to express the quantity theory of money as the equation: M.

.The Liquidity of Assets • Liquidity is an ability to quickly and easily convert an asset into spendable money at a price near its maximum market value.

current accounts). . • Broad definitions of money include items that cannot be spent directly but can be readily converted into cash.Monetary Aggregates • Narrow definitions of money include items that can be spend directly (cash.

documentation requirement and the mode of payment are the various factors which together comprise the “Terms of Credit”.Credit Credit is finance made available by one party (lender. • Terms of Credit : The interest rate. collateral. or shareholder /owner ) to another. seller. .

Sources of credit • Formal Sources of Credit -registered by the Government and have to follow its rules and regulations • Informal Sources of Credit-small and scattered units which are outside the control of the Government .

BANKING SYSTEM • Banking system occupies an important role in nations economy. • Banking institution is indispensable in a modern society. . • It forms the core of the money market in an advanced country.

Money market characterized in 2 segments 1.Unorganised . Organized 2.

Organized Sectors • • • • It includes :Commercial Banks Co-operative banks Regional Rulers banks .

Unorganized Sectors • It includes :• Money Lenders • Indigenous bankers .

Role of Commercial Banks • • • • Encourage the saving and capital formation Mobilization of saving Optimum utilization of saving Promotes economic growth .

Function of a Bank • Receipt of Deposits (a) Demand deposits or current deposits (b) fixed deposits or time deposits (c) Saving deposits .

• Lending of Money (a) Cash Credits (b) Overdrafts (c) Loans and advances (d) Discounting of bills of exchange .

premium. etc. Purchase and sale of shares and securities Acting as trustee or executor when so nominated Making regular payments such as insurance premiums etc. promissory notes and cheques Collection of dividends. .Agency Services • • • • • Collection of bills . interest.

travelers cheques.• General Services (a) Issuer of letter of credit. bank drafts. circular notes (b) Safe keeping of valuables in safe deposit vaults (lockers) (c) Supplying trade information and statistics (d) Conducting economic surveys .

Banking System Industrial Development Bank of india NABARD Exim bank IRBI National Housing Bank .

Banking institutions Commercial banks Regional rural banks Co-operative banks Public sectors banks Private sectors banks Indian State bank group Nationalised banks Foreign .

•These sources vary from country to country in form. •Credit is provided in an economy also by sources other than banks. price. but they in general include consumers and producers in various sectors of the economy at home and abroad. Interest is the price that guides them in making business decision. and allocation. •The end users of credit the system creates may also vary much across nations. . •Credit Creation is not entirely independent of the overall financing environment of a country.•Commercial banks are essentially dealers in credit.

Money Policy & Credit Policy .

.  Monetary policy operates through varying the cost and availability of credit.  The level and nature of economic activities such an economy are influenced by the cost and availability of the credit. Monetary Policy refers to the use of instrument within the control of the Central Bank to the influence the level of aggregate demand for the goods and services or to influence in certain sector of the economy.

• M 2 includes all M1 + – Saving deposits and small time deposits – Assets that act as media of exchange and other very liquid assets that can be converted into media of exchange very easily at little cost.Measures of Money Stock • The M1 money supply includes: – Assets that serve as media of exchange. • M 3 includes all of M 2 + – Large –denomination time deposits – Other less liquid savings instruments .

• L is a broad measure of liquid assets. which includes M 3 +: – Short-term treasury securities – Commercial papers near money – Other liquid assets • D includes all forms of credit money: Any future monetary claim that can be used to buy goods and services. . There are many forms of credit money.

General Methods 2.Instruments of Monetary Policy Instruments of monetary policy are divided into : 1.Selective Methods .

• There are three general or quantitative instruments of credit control.General Credit Control • The general methods affect the total quantity of credit and affect the economy generally. Variable Reserve Requirements . 1. The Bank Rate 2. Open Market Operations 3.

• In India. such controls have been used to prevent speculative hoarding of commodities like food grains and essential raw material to check an under rise in their prices. .Selective Credit Regulation • Selective or Qualitative credit control refers to regulation of credit for specific purpose or branches of economic activity.

Credit Policy Guidelines addressing how a company evaluates potential customers who wish to buy on credit. . Guidelines include credit terms that specify• Discounts • Interest rate • Credit limit.

A credit policy of a firm provides the framework to determine  Whether or not to extend credit to a customer and  How much credit to extend. . Credit policy is the determination of credit standards and credit analysis. The credit policy of a firm has two dimensions:  Credit standards and  Credit analysis.

The credit standards may be – Tight or restrictive .Credit Standards  It represents the basic criteria or minimum requirement for extending credit to a customer.Liberal or non restrictive .

bank references and specialist bureau reports. . the past records of the firm etc.Analysis of Credit Information Quantitative.It is based on the factual information available from the financial statements. Qualitative: here the information are obtained from the suppliers.