Money

• Money is the commonly accepted medium of exchange, payment for goods & services, repayment of debt
• In an economy if there are more than one economic agent who engage themselves in transactions through the market, money becomes an important instrument for facilitating these exchanges.
• Economic exchanges without the mediation of money are referred to as barter exchanges. However, they presume the rather improbable double coincidence of wants.
• to smoothen the transaction, an intermediate good is necessary which is acceptable to both parties. Such a good is called money.
• The individuals can then sell their produces for money and use this money to purchase the commodities they need.
• Purpose of Money
• Medium of exchange.
• Unit of account – Measure of value.
• Store of value.
• Standard for deferred Payments (creditor payment).

Money Standard

• Gold Standard (Used till WW-II)

(Ex: 1kg gold in US is 5000$, 1kg Gold in India is Rs.5000. [1000$ = Rs. 5000. So, 1$ - Rs. 5.])

Country print money how much their gold reserves. But now country can print money how much they need {but need to manage floating, otherwise high printing lead to inflation. So printing money based on Assert of the country (Gold, Foreign currency etc..) is advisable}).

• Currency Notes
• Plastic Money (Credit Card, Debit Card)
• Cryptocurrencies (Digital Currency)

Money used for transaction

• Fiat Money (Token Currency, value given by authority. Ex: paper has value of 500, 2000).
• Legal Tender (Things accepted for legal transaction. Ex: Rupee in India)

Why there is need for Money?

• Transaction Motive
• Precautionary Motive
• Speculative Motive

Money Creation

The Currency Deposit Ratio

• (Ex: Income 50,000. Keep 25,000 as cash in hand & 25,000 deposited in bank.)
• More deposit, bank has more money to give as loan.
• The currency deposit ratio (cdr) is the ratio of money held by the public in currency to that they hold in bank deposits. (For simplicity consider only demand deposits)

cdr = CU/DD

The Reserve Deposit Ratio

(CRR & SLR percentage is high, less money in bank to give less loan.

CRR & SLR percentage is low, more money in bank to give more loan)

• Banks hold a part of the money people keep in their bank deposits as reserve money and loan out the rest to various investment projects.
• Reserve money consists of two things – vault cash in banks and deposits of commercial banks with RBI.
• Banks use this reserve to meet the demand for cash by account holders. Reserve deposit ratio (rdr) is the proportion of the total deposits commercial banks keep as reserves.

Money Multiplier Effect (m)

• Money Multiplier Effect is deriving by Currency Deposit Ratio & Reserve deposit Ratio

Bank	Deposit	Reserve (10%)	Loan
Bank A	100	10	90 to Bank B
Bank B	90	9	81 to Bank C
Bank C	81	8.1	72.9 to Bank D
Bank D	72.9	7.29	65.61 to Bank E
Bank E	65.61	6.561	58.959 to Bank F
Bank F	58.959	5.8959	53.0631 to Bank G…

The real deposit is 100 Rupees. But the money multiple effect by loan.

• A money multiplier is an approach used to demonstrate the maximum amount of broad money that could be created by commercial banks for a given fixed amount of base money and reserve ratio.
• The money multiplier, m, is the inverse of the reserve requirement, R:m= 1/R or M3/M0.
• For example, with the reserve ratio of 10 per cent, this reserve ratio, R, can also be expressed as a fraction: 1/10
• So then the money multiplier, m, will be calculated as: 1/ (1/10) = 10.
• This number is multiplied by the amount of reserves to estimate the maximum potential amount of the money supply.
• For example, from Rs.100 can be multiplied by 5 to generate Rs.500 money supply if Reserve Ratio is 1/5 (20%) or when Money Multiplier is 5. When Reserve Ratio is 1/4 (25%) or when Money Multiplier is 4, that would generate only Rs. 400 as money supply.

Money supply

• Money supply is the amount of money in circulation in the economy at any point of time.
• It not only includes the currency & coins in circulation, but it also includes demand & time deposits of banks, post office deposits and such related instruments.
• Valuation and analysis of the money supply helps the economist and policy makers to frame the policy or to alter the existing policy of increasing or reducing the supply of money.
• The understanding of money supply is important as it ultimately affects the business cycle and thereby affects the economy.
• RBI Publishes the monetary statistics data
• The method of compilation had undergone revision three times. 1961,1977 and 1997 (Y.V.Reddy Commission)
• Money is set of liquid financial assets, the variation in the stock which could impact on aggregate economic activity
• The Third working group recommended for two different financial aggregates namely
• Monetary aggregate (M0, M1, M2, M3)
• Liquidity aggregates (L1, L2, L3)

Monetary Aggregates

• M0 (Reserve Money): (liability of RBI) Currency in circulation + Bankers’ deposits with the RBI + ‘Other’ deposits with the RBI. (High powered Money)
• {These money does it multiple. Ex: Rs.100 initial deposit & Reserve ratio}
• (RBI credit to the Government + RBI credit to the commercial sector + RBI’s claims on banks + RBI’s net foreign assets + Government’s currency liabilities to the public – RBI’s net non-monetary liabilities).
• M1: Currency with the public (Cash in Circulation) + Deposit money of the public (Demand deposits with the banking system (Narrow Money).
• M2: M1 + Savings deposits with Post office savings banks. (Intermediate Money).
• M3: M1+ Time deposits with the banking system (Broad Money).
• M4 = M3 + Total deposits with the Post Office (Broad Money).
• M0 - Compiled at weekly Basis. M1, M2 & M3 - Compiled every fortnight (14 days).
• In addition to the monetary measures stated above, the following liquidity aggregates to be compiled on monthly basis were also recommended by the working group:

Liquidity aggregates

2009, Y. V. Reddy Recommendation for non-banking financing institution.

• L1 (M4) = M3 + All deposits with the Post Office Savings Banks (excluding National Savings Certificates [Bond released by post office for 8 Years]).
• L2 = L1 + Term deposits with Term lending institutions and refinancing Institutions (FIs) + Term borrowing by FIs + Certificates of Deposits issued by FIs.
• L3 = L2 + Public deposits of Non-Banking Financial Companies.
• (L3 is compiled on quarterly basis)