*DAY #18 13.04.2020*
*TOPIC – MONEY AND ITS SUPPLY*
(Quiz link is given in the last of content)
MONEY
– Money is anything which
is generally accepted as a medium of exchange, measures of value, store of
value and standard of deferred payment.
In
other words, Money is any good that is widely used and accepted in
transactions involving the transfer of goods and services from one person to
another. {Money =
Currency held by the public (C) + Demand Deposits (DD)}
CHARACTERISTICS OF MONEY - The characteristics of money
are durability, portability, divisibility, uniformity, limited
supply, and acceptability.
BARTER
ECONOMY
BARTER
SYSTEM – Barter exchange refers to exchange of
goods for goods. An economy, where there is a direct barter of goods and
services, is called a ‘Barter Economy’ or ‘C-C Economy’.
DRAW
BACKS OF BARTER SYSTEM –
1. Problem of
Double Co incidence of Wants – A can exchange goods with B only when A has what
B wants and B has what A wants.
2. Lack of
Common Measure of Value
3. Lack of
Standard of Deferred Payment
4. Difficulty in
Storing Wealth
5. Lack of
Divisibility.
EVOLUTION OF MONEY –
Cattle, which throughout history and
across the globe have included not only cows but also sheep, camels, and other
livestock, are the first and oldest form of money. With the
advent of agriculture also came the use of grain and other vegetable or plant
products as a standard form of barter in many cultures. Briefly, evolution of money was mainly through
commodity money, metallic money, paper money and bank money.
Human beings passed through a stage when money was not in use and
goods were exchanged directly for one another. Such exchange of goods for goods
was called Barter Exchange.
There are five stages of
evolution –
1.
Commodity Money(Goods),
2.
Metallic Money(Coins),
3.
Paper Money(Bank Notes),
4.
Credit Money(Cheques & DDs) and
5.
Plastic Money(Credit & Debit
Cards).
(Just for information)
Fiat Money –
It is the money backed by order (fiat) of the government.
Fiduciary Money –
It is the money backed by mutual trust between the payer and the payee.
Full bodied money –
Money in terms of coin whose commodity (intrinsic) value is equal to its money
value is called full bodied money.
Credit Money –
It refers to money where money value is more than the commodity (Intrinsic)
value.
Legal
Tender Money – Has a legal sanction by the government.
Liquidity –
The ease with which any asset can be converted in to cash without loss of value
or time.
FUNCTIONS OF MONEY – (For
information)
(Money has overcome the
drawbacks of barter system)
1- Medium of Exchange –
it
means that money acts as a medium for the sale and purchase of goods and
services. A buyer can buy goods through money and a seller can sell goods for
money. In the absence of money, goods were exchanged for goods. This required
double coincidence of wants. It has removed the major difficulty of the double
coincidence of wants.
2-
Measure of Value -
Money
serves as a measure of value in terms of unit of account. Unit of account means
that the value of each good or service is measured in the monetary unit.
Measurement of value was very difficult in the barter system one good was
valued in terms of the other. Introduction of money has removed this
difficulty. It acts as a yardstick of standard measure of value to which all
other things can be compared.” Money measures the value of everything or the
prices of all goods and services can be expressed in terms of money. This
function of money also enables the trading firms to ascertain their costs,
revenues, profits and losses.
3- Standard of Deferred
Payments – Deferred Payments referred to those
payments which are to be made in near future. Money act as a standard of
deferred payments due to the following reasons –
* Value of money
remains more or less constant compared to other commodities.
*
Money has the merit of general acceptability.
*
Money is more durable compared to other commodities.
4- Store of Value –
Money can be stores and does not lose value. Money acts as a store of value due
to the following reasons.
*
It is easy and economical to store.
*
Value of money remains relatively constant.
Money has the
merit of general acceptability.
MONEY SUPPLY
IN INDIA -
Simply the money supply is the total stock of money that is in
circulation in an economy on any specific day. It includes all the notes, coins
and demand deposits held by the public on such a day. Such as money demand,
money supply is also a stock variable
As the stock of money kept with the government, central bank, etc. is not
in actual circulation in the economy, and hence does not form a part of the
monetary supply. So this is not taken into account in money supply.
SOURCES OF
MONEY SUPPLY
There are three
main sources of money supply in our economy. They are the producers of the
money and are responsible for its distribution in the economy.
i.
The government who produces all the coins and the one
rupee notes;
ii.
The Reserve Bank of India (RBI) which issues all the
paper currency;
iii.
And commercial banks as they create the credit as per
the demand deposits.
MEASURES OF
MONEY SUPPLY IN INDIA
To measure the money supply in India, Reserve Bank of India has
developed four alternative measures of money supply. These four alternative
measures of money supply are labeled M1 (Narrow Money), M2 (Narrow Money), M3 (Broad
Money) and M4 (Broad Money). The RBI will collect data and calculate and
publish figures of all the four measures. Let us take a look at how they are
calculated.
M1
(NARROW MONEY)
M1 includes:
1.
All the currency
notes being held by the public on any point of time.
2.
It also includes
all the demand deposits with all the banks in the country, both savings as well
as current account deposits.
3.
It also includes
all the other deposits of the banks kept with the RBI.
Paper money and coins are the most
significant component of a nation’s money supply. M1 money is a country’s basic
money supply that's used as a medium of exchange. M1 money is the money supply
metric most frequently utilized by economists to reference how much money is in
circulation in a country. M1 is so narrowly defined, because, very few
components are classified as M1.
So,
M1 = CC + DD +
Other Deposits
M2 (NARROW MONEY)
M2, also
narrow money, includes:
1.
All the inclusions
of M1
2.
It also includes
the saving deposits of the post office banks.
M2 is a
measure of the money supply that includes cash, deposits, and easily convertible
near money. M2 is a broader measures of the money supply that M1, which just
include cash and deposits. M2 is a closely watched as an indicator of money
supply and future inflation, and as a target of central bank monetary policy. These
assets are less liquid than M1 and not as suitable as exchange mediums, but
they can be quickly converted into cash or checking deposits.
So,
M2 = M1 +
Savings Deposits of Post Office Savings
M3
(Broad Money)
M3 consists of all currency notes held by the public, all demand
deposits with the bank, deposits of all the banks with the RBI and the net Time
Deposits of all the banks in the country. The M3 classification is the broadest measure of an
economy's money supply. It emphasizes money as a store-of-value more so than as
a medium of
exchange —
hence the inclusion of less-liquid assets in M3. The M3 measurement includes
assets that are less liquid than other components of the money supply and are
referred to as "near, near money,"
So,
M3 = M1 + time
deposits of banks.
M3 = M1+ Time
deposits with the banking system = (Net bank credit to the Government + Bank
credit to the commercial sector + Net foreign exchange assets of the banking
sector + Government’s currency liabilities to the public – Net non-monetary
liabilities of the banking sector (Other than Time Deposits).
M4 (BROAD MONEY)
M4 is the widest measure of money supply that the RBI uses. It includes
all the aspects of M3 and also includes the savings of the post office banks of
the country. It is the least liquid measure of all of them.
So,
M4 = M3 + All
deposits with Post office Savings Banks
AT A GLANCE
M1=currency held
by public + Demand deposits + other deposits with Reserve Bank of India.
M2=M1+saving
deposits with post office saving bank
M3=M1+net time
deposit with the bank
M4=M3
+ total deposits with post office saving bank excluding national saving
certificate.
HIGH POWERED MONEY –
High powered money or powerful money refers to that currency that has been
issued by the Government and Reserve Bank of India. Some portion of this currency is kept along
with the public while rest is kept as funds in Reserve Bank. High
powered Money (H) includes currency with Public
(C), important reserves of Commercial banks and other reserve (ER). In other words, it consist of two things: Currency
held by the public (C) + Cash reserves with banks (CR) H =C+CR
MONEY
MULTIPLIER –
The monetary base (The monetary base is either held
by the public as currency or held by the banks as reserves) has a multiplier
effect on the money supply. How many times the total deposits would be of the
initial deposit is determined by the money multiplier. Money multiplier is
depends on the value of Legal Reserve Ratios. Let us understand with an
example –
The multiple called the money or deposit
multiplier, is:
Money multiplier = 1/ LRR
If LRR is 20 percent or 0.2
Therefore,
Money multiplier = 1/(20/100)
= 1/0.20
Money Multiplier = 5
QUIZ LINK
REFERENCE VIDEO LINK –
Money and Its Supply
Please
like, Share Subscribe and download app from play store by link given in
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Regards
Dr.
Asad Ahmad
KV
IIM, Lucknow
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