MEANING OF MONEY

In ordinary conversation, we commonly use the word money to mean income ("he makes a lot of money") or wealth ("she has a lot of money").

Money ( or money supply) refers to anything that is

generally accepted in payment for goods or

services or in the repayment of debts.

Money is a stock concept. It is a certain amount at a given point in time.

TYPES OF MONEY: Money consists of Currency: The paper notes and coins that people use in a country. They are money because government declares them so. (legal tender) Deposits at banks and other depository institutions are also money. Deposits are money because they can be converted into currency and because they are used to settle debts.

Medium of exchange Standard of value

Store of value
Standard of deferred payment

The most important job of money is to serve as a medium of exchange

When any good or service is purchased, people use

money
Money makes it easier to buy and sell because money

is universally accepted
Money, then, provides us with a shortcut in doing

business

By acting as a medium of exchange, money performs its most important function

Money facilitates exchange by reducing the cost of trading.

Without money, we would have to barter.

Money does not have to have any inherent value to function as a medium of exchange.

All that is necessary is that everyone believes that other people will exchange it for their goods.

Money is a common denominator in which the relative value of goods and services can be

expressed
A job that pays $2 an hour would be nearly

impossible to fill, while one paying $50 an hour

would be swamped with application

Store of Value

The function of money as a store of value refers to the use of money to save purchasing power from

the time income received until the time it is spent.

This function facilitates the exchange of goods and services over time.

Money is not unique as a store of value. There are many other assets can be used as a store of value

such as stocks, bonds, real estate, collectibles,

arts, etc.

In fact many such assets have advantages over

money as a store of value. They earn a return while money (as cash) does not earn a return.

However, money is the most liquid of all assets because it is the medium of exchange; it does

not need to be converted into anything else to

make money. purchase. Other assets involve

transaction costs when they are converted into

Money is used as a common denominator to measure the relative values of goods and services.

Without money, we would have to measure the

value of goods and services in terms of other goods

and services.

Money is a useful unit of account only if its value relative to the average of all other prices doesnt change too quickly.

The money multiplier (also called as Credit multiplier or debit multiplier) is the measure of extent to which the creation of money in the banking system causes the growth in the money supply to exceed in the monetary base.

Some terminologies:

Monetary Base B (also reserve money) Reserve-deposit ratio rr (minimum reserves each commercial bank must hold) Currency-deposit ratio cr (Refers to the amount of currency (C) people hold as a fraction of their deposits (D)). Money Multiplier m Money supply M (or money stock, the amount of money in the economy.)

 The money multiplier is a multiplicative factor on the monetary base. E.g. If multiplier is 10, then Rs. 1 increase in monetary base will increase the money supply by 10 times.
M= m*B m= 1 +cr/cr+rr
Where
M= Money supply ( M=C+D) m= Money Multiplier B= Monetary Base

Changes in the required reserve ratio (rr) The money multiplier and the money supply are negatively related to rr Changes in the currency ratio (cr) The money multiplier and the money supply are negatively related to cr Changes in the excess reserves ratio (er) The money multiplier and the money supply are negatively related to the excess reserves ratio e
The excess reserves ratio e is negatively related to

the market interest rate

The excess reserves ratio e is positively related to

expected deposit outflows

A Bank has a Reserve Ratio (RR) of 20% and an initial deposit of 100.00 Calculate: the money multiplier and the re-lending process assuming no currency drain

Calculate Money Multiplier (m): m = 1 /RR =1 /0.2 = 5

The money multiplier model asserts that, in a fractional-reserve banking system, the total quantity of loans that commercial banks can extend (the bank credit money they are allowed to create) is a multiple of the quantity of reserves they hold in advance of the loans they extend. This multiple is a money multiplier and is the reciprocal if the reserve ratio.

 Measures of money are typically classified as levels of M

The monetary base or high powered money is smallest and lowest M-level: M0. Base money can be described as the most acceptable (or liquid) form of final payment. The govt. institutions generally control change in the monetary base through open market transactions (like the buying and selling of government bonds). They also typically have the ability to influence banking activities by manipulating interest rates and changing bank reserve requirements

The monetary base is called high-powered because an increase in the monetary base (M0) can result in a much larger increase in the supply of bank money, an effect often

referred to as the money multiplier.

An increase of 1 billion currency units in the monetary base will allow (and often be correlated to) an increase of several

billion units of "bank money.

Consider the following example:

Suppose there is a $100 deposit of gold coins. Assume the Reserve Ratio (e) is 10%, so the bank keeps 10% of all deposits as reserves. Therefore, the bank can loan out the remaining $90 of gold coins. Assuming the public holds no currency, the new $90 loan will be spent and then redeposited by the new holder of the $90 The bank keeps $9 to meet the 10% reserve requirement and then can make another loan of $81. This process repeats and repeats and ultimately the original deposit of $100 leads to the creation of upto $1000 units of money, all in the form of bank deposits!

Money is anything that serves the commonly accepted medium of exchange.

Medium of exchange Store value Unit of account

Transaction motive

Precautionary motive

Speculative motive

In economics, the money supply or money stock, is the total amount of monetary assets available in an economy at a specific time. Money supply data are recorded and published, usually by the government or the central bank of the country. Public and private sector analysts have long monitored changes in money supply because of its possible effects on the price level, inflation, the exchange rate and the business cycle.

Monetary policy refer to steps taken by RBI to regulate cost and supply of money in order to achieve certain Socio Economic objective like price stabilization full employment, exchange regulation and increased economic growth.

There is no unique measure to money aggregate M : M1 + M2 + M3 + M4

It consist of Currency notes and coins with public ( excluding cash in hand of all banks). Demand deposit ( excluding inter bank deposit) Deposit held with RBI ( excluding IMF,PF, guarantee fund & adhoc liabilities). N A RROW MONEY

Consists of M1 Saving deposit with post office saving bank. Represents money and "close substitutes" for money. M2 is a broader classification of money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions. M2 is a key economic indicator used to forecast inflation.

 Consists of M1

Time deposit of commercial bank & cooperative bank ( excluding inter bank deposit) It includes net bank credit to government +bank credit to commercial sector + net foreign exchange assets + government currency liability to the public BROAD MONEY

Consists of M3 All deposits with post office savings banks (excluding National Savings Certificates).

If we see the components of money supply, we can see bank deposits form bulk of the money supply. Within deposits, it is time deposits which form around 3/4th of the money supply. The share of time deposits has declined from 74.7% in Oct Dec 09 to 74% on 9 April 2010. The share of demand deposits has risen from 11.3% in Oct Dec 09 to 12% on 9 April 2010. The percentage contributions of each item in components of money supply do not change much in the year.

Components of Money Supply (in %)

April 09 June 09 Currency with the public Demand deposits with banks Other deposits with RBI Time deposits with banks Money Supply 14.1 11.4 0.2 74.3 100.0 July 09 Oct 09 Jan 10- As on Apr Sep 09 Dec 09 Mar 10 9, 2010 13.6 11.6 0.1 74.7 100.0 13.9 11.3 0.1 74.7 100.0 14.0 12.0 0.1 74.2 100.0 13.9 12.0 0.1 74.0 100.0

As both demand and time deposits form around 75% of money supply, whatever the growth in deposits, is also the growth in money supply. RBI changes both these targets together and keeps them near similar.

The growth in money supply must be higher then the growth in the real national Income This stems for two reasons As income grows ,the demand for money as one of the component of saving tends to increase. An increase in money supply is also necessitated by gradual reduction of the non-mentioned sector of the economy. been far

(i)

(ii)

In our country, the rate of increase in money supply has excess of the rate of growth in real national income.