1
MONETARY SYSTEM
Money
Anything which has general acceptance as means of payment.
Functions of Money:-
o Medium of Exchange
o Common measure of value
o Standard for deferred payments
o Store of wealth
Barter System – A commodity is exchanged for other
commodities.
o Problems of barter System are:-
Double coincidence of what is required
Valuation of commodities exchanged is a problem
There won’t be a standard to serve as future monetary obligations
Gresham’s Law – Bad money drives out good money
Legal Tender Money – This money cannot be denied in the settlement of monetary obligation
Types of Money
1. Full-bodied money
• It is the type of money whose value as money is equivalent to its value as commodity
• E.g. – Gold coin
2. Token Money/Credit Money/Paper
Money
• Value as money is much more than the value as commodity
• E.g. – Paper Currency
3. Representative full-bodied money
• It is a kind of token money but is issued against the backing of equivalent value of bullion (gold and silver in bulk) with the issuing authority
o Limited Legal Tender Money : It is compulsory to accept upto a certain limit
E.g. A sum of `10 can be paid in denominations of 50 paisa coins and the
recipient has to legally accept it.
o Unlimited Legal Tender Money : This money can be used to make any amount of payment
Non Legal Tender Money – There is no legal compulsion to accept this money. It is also called optional money or Fiduciary Money (on the basis of trust).
o E.g. – Nepalese currency at India – Nepal border may be used as but recipient is not legally bound to accept it.
Fiat Money – Serves as money on the order of the government. It is issued by government and theoretically may not be compulsory to accept.
Near Money – Highly liquid financial assets like shares and bonds
MONEY SUPPLY
Money Supply is the total stock of all types money (currency + deposit money) held with public
Types of bank deposits
o Savings Account o Current Account o Fixed deposit
o Recurring deposit account
M1 = C + DD + OD (Narrow Money)
C - Currency held by the public
DD - Demand Deposits with Banks
OD - Other deposits (Demand Deposits held by RBI)
Public refers to everybody except
Banks and Government
Demand Deposits (DD) – Can be withdrawn on demand from banks.
Time Deposits (TD) – Can be withdrawn only after a specific time.
DD+TD = Total Deposits
Other deposits include demand deposits with RBI. DD with RBI can be held only by Quasi- Governmental agencies, international agencies or former Governors of RBI
M1 is known as narrow money as it includes only 100% liquid deposits which is a very narrow definition of money supply.
M2 = M1 + Savings account deposits with Post Offices
M2 includes M1 and only saving account deposits with Post offices.
Though the size of post office saving accounts is negligible M2 term is used as all the deposits in M2 are not liquid.
M3 = M1 + TD (Broad Money)
TD - Time Deposits with Banks
Includes fixed deposits, Recurring deposits and
time liability of Savings accounts
M3 is called Broad money as along with liquid deposits it also includes time deposits thus making it a broad classification of Money
M4 = M3 + Total Deposits with Post Office
As the total deposits with post office is negligible there is not much difference between M3 and M4
The most common measure used for money supply is M3
Currently M3 is `76 lakh crore.
MONETARY SYSTEM
Money
Anything which has general acceptance as means of payment.
Functions of Money:-
o Medium of Exchange
o Common measure of value
o Standard for deferred payments
o Store of wealth
Barter System – A commodity is exchanged for other
commodities.
o Problems of barter System are:-
Double coincidence of what is required
Valuation of commodities exchanged is a problem
There won’t be a standard to serve as future monetary obligations
Gresham’s Law – Bad money drives out good money
Legal Tender Money – This money cannot be denied in the settlement of monetary obligation
Types of Money
1. Full-bodied money
• It is the type of money whose value as money is equivalent to its value as commodity
• E.g. – Gold coin
2. Token Money/Credit Money/Paper
Money
• Value as money is much more than the value as commodity
• E.g. – Paper Currency
3. Representative full-bodied money
• It is a kind of token money but is issued against the backing of equivalent value of bullion (gold and silver in bulk) with the issuing authority
o Limited Legal Tender Money : It is compulsory to accept upto a certain limit
E.g. A sum of `10 can be paid in denominations of 50 paisa coins and the
recipient has to legally accept it.
o Unlimited Legal Tender Money : This money can be used to make any amount of payment
Non Legal Tender Money – There is no legal compulsion to accept this money. It is also called optional money or Fiduciary Money (on the basis of trust).
o E.g. – Nepalese currency at India – Nepal border may be used as but recipient is not legally bound to accept it.
Fiat Money – Serves as money on the order of the government. It is issued by government and theoretically may not be compulsory to accept.
Near Money – Highly liquid financial assets like shares and bonds
MONEY SUPPLY
Money Supply is the total stock of all types money (currency + deposit money) held with public
Types of bank deposits
o Savings Account o Current Account o Fixed deposit
o Recurring deposit account
M1 = C + DD + OD (Narrow Money)
C - Currency held by the public
DD - Demand Deposits with Banks
OD - Other deposits (Demand Deposits held by RBI)
Public refers to everybody except
Banks and Government
Demand Deposits (DD) – Can be withdrawn on demand from banks.
Time Deposits (TD) – Can be withdrawn only after a specific time.
DD+TD = Total Deposits
Other deposits include demand deposits with RBI. DD with RBI can be held only by Quasi- Governmental agencies, international agencies or former Governors of RBI
M1 is known as narrow money as it includes only 100% liquid deposits which is a very narrow definition of money supply.
M2 = M1 + Savings account deposits with Post Offices
M2 includes M1 and only saving account deposits with Post offices.
Though the size of post office saving accounts is negligible M2 term is used as all the deposits in M2 are not liquid.
M3 = M1 + TD (Broad Money)
TD - Time Deposits with Banks
Includes fixed deposits, Recurring deposits and
time liability of Savings accounts
M3 is called Broad money as along with liquid deposits it also includes time deposits thus making it a broad classification of Money
M4 = M3 + Total Deposits with Post Office
As the total deposits with post office is negligible there is not much difference between M3 and M4
The most common measure used for money supply is M3
Currently M3 is `76 lakh crore.
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