MONEY

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BARTER SYSTEM

 Exchange of goods for goods is called Barter system.

 An economy where there is direct barter of goods and services is called Barter Economy, it
is also called as C-C economy.

 Difficulties involved in the Barter Exchange:

 1. Lack of a common measure of value
 2. lack of double coincidence of wants
 3. Lack of standard of deferred payments
 4. Lack of store of value
 5. Lack of divisibility
 6. Difficulty in exchange of services.
 MONEY HAS OVERCOME THE DRAW BACKS OF BARTER
SYSTEM:
 MEDIUM OF EXCHANGE: Money has removed the major difficulty
of the double coincidence of wants.
 MEASURES OF VALUE: Money has become measuring rod to
measure the value of goods and services and is expressed in terms
of price.
 STORES OF VALUE: It is very convenient, easy and economical to
store the value and has got general acceptability which was
lacking in the barter system.
 STANDARD OF DEFERRED PAYMENTS: Money has simplified the
borrowing and lending of operations which were difficult under
barter system. It also encourages capital formation.
MEANING OF MONEY

 Money is anything which is generally accepted as medium of exchange and at the

same time acts as a measure, store of value and standard of deferred payment.
 VARIOUS DEFINITION OF MONEY:
 (i) Legal Definition of Money:
 According to law, “Money is what the law says it is”. Money has legal tender
power.
 That is, it can be used to discharge debt.
 Legally money can be of two kinds

NON LEGAL
LEGAL TENDER
TENDER
MONEY
MONEY
LEGAL TENDER MONEY & NON-LEGAL
TENDER MONEY
 LEGAL TENDER MONEY:
 It means money under the law of land.
 Currency (coins and notes) is legal tender money.
 It is also called fiat money because it serves as money in the fiat or order of the
government.
 The legal tender status given by the government to money may be limited or unlimited.
 NON-LEGAL TENDER MONEY
 It is optional and voluntary money which is generally accepted as money on the basis of
trust that issues commands.
 It is also called fiduciary money because it is accepted as money on trust.
FUNCTIONS OF MONEY

 PRIMARY /BASIC FUNCTION:

 (i) Medium of exchange: It can be used in making
payment for all transactions of goods and services.
 (ii) Measures /Units of value: It helps in measuring the
value of goods and services. The value is usually called
as price. After knowing the value of goods in single unit
(price) exchanges become easy.
 FUNCTIONS OF MONEY

SECONDARY FUNCTION:
 (i) Standard of deferred payments: Deferred payments referred to those payments which are to be made in near future.
 Money acts as a standard deferred payment due to the following reasons:
 (a) Value of money remains more or less constant compared to other commodities.
 (b) Money has the merit of general acceptability.
 ( c) Money is more durable compare to other commodity.
 (ii) Store of value : Money can be stored and does not lose value
 Money acts as a store of value due to the following reasons:
 (a) It is easy and economical to store.
 (b) Money has the merit of general acceptability.
 © Value of money remains relatively constant.
 FORMS OF MONEY

 (I) Fiat money and Fiduciary money

 (II) Full bodied money and credit money
 Fiat Money: It refers to that money which is issued by order/ authority of the government.
 Fiduciary Money: It refers to that money which is accepted as a medium of exchange because of
the trust between the payer and the payee.
 Full Bodied Money: It refers to the money in term of coins whose commodity value is equal to the
money value as and when these are issued.
 [Money value = Commodity value]
 Credit Money: It refers to that money of which money value is more than commodity value.
 [Money Value > Commodity Value]
MONEY SUPPLY

Total stock of money (currency notes, coins and

demand deposit of banks) in circulation are held
by the public at a given point of time.
Supply of money does not include cash balance
held by central and state govt. and stock of
money held by banking system of country as they
are not in actual circulation of the country.
Measures of Money Supply = Currency held by Public + Net
Demand Deposits held by commercial banks
M1 = C + DD + OD
C = Currency and coins with the public
DD = Demand deposits of the public with the banks
OD = Other deposits
M2 = M1+ Post office savings deposits
M3 = M1+ Time deposits of commercial banks
M4= M3+ Total deposits with the post office saving organisation
excluding the deposits on NSC.

HIGH POWERED MONEY: It refers to currency with the public

(notes + coins) and cash reserve of banks.
 BANKING
COMMERCIAL BANK & CENTRAL BANK
COMMERCIAL BANK

 A commercial Bank is a financial institution which performs the functions of accepting deposits
from the general public and giving loans for investment with the aim of earning profit.
 Ex- Punjab National Bank, Allahabad Bank, Canara Bank, Andhra Bank. Etc
 FUNCTIONS OF COMMERCIAL BANK:
 1. Acceptance of Deposits
 2. Advancing Loans
 3. Discounting Bills of exchange or hurdles
 4. Overdraft facility
 5. Agency functions of the bank
 6. Performing general utility services
 7. Money (credit) creation
 MONEY CREATION /DEPOSIT CREATION/CREDIT
CREATION BY COMMERCIAL BANK

 Let us understand the process of credit creation Deposits Loans CRR(20

with the following example: %)
 Suppose there is an initial deposit of Rs 1000 Initial 1000 800 200
and LRR is 20% i.e. the banks have to keep rs deposit
200 and lend Rs 800. All the transactions are First 800 640 160
routed through banks. The borrower withdraws round
his Rs 800 for making payments which are
Second 640 512 128
routed through banks in the form of deposits
round
account.
- - - -
 The Bank receives Rs 800 as deposit and keeps
20% of Rs 800 i.e Rs 160 and lends Rs 640. Again - - - -
the borrower uses this for payment which flows - - - -
back into the banks thereby increasing the flow Total 5000 4000 1000
of deposits
 CRR AND CREDIT MULTIPLIER

 Demand Deposits = 1/ CRR x cash reserves

 = 1/20% * 1000
 = 1/0.2 * 1000
 = 5000

 CRR is determined not by the commercial banks themselves but by the RBI.
 Also, the commercial banks are required to keep the stipulated cash reserves not with themselves, but with the RBI.
 Once CRR, is known, we can find out “credit multiplier” or the number of times the commercial banks can create credit, per unit of their
cash reserves with the RBI.
 Credit Multiplier is found in terms of the following equation: K= 1/ CRR
 K = Credit Multiplier, CRR = Cash Reserve Ratio
 Why only a fraction deposits is kept as cash reserve?
 (a) All depositors do not withdraw the money at the same time.
 (b) There is constant flow of new deposits into the banks.
CENTRAL BANK

 An apex body that controls, operates, regulates and directs the entire banking and
monetary structure of the country.
 FUNCTIONS OF THE CENTRAL BANK
 1. Currency authority or Bank of issuing notes
 2. Banker to the Government
 3. Bankers’ Bank and supervisory Role
 4. Controller of money supply and credit
 5. Lender of the last resort
 6. Custodian of foreign exchange reserves
 7. Clearing House function
1.CURRENCY AUTHORITY [OR] BANK OF ISSUING
NOTES:
• Central Bank is a sole authority to issue currency in the country.
• Central Bank is obliged to back the currency with assets of equal value ( usually gold coins, gold billions, foreign
securities etc.)
• Advantages of sole authority of note issue:
• (a) Uniformity in note circulation
• (b) Better supervision and control
• ( c ) It is easy to control credit
• (d) Ensures public faith
• € Stabilization of internal and external value of currency

2. BANKER TO THE GOVERNMENT:

• As a banker it carries out all banking business of the government and maintains current account for keeping cash balances
of the government.
• Accepts receipts and makes payments for the government.
• It also gives loans and advances to the government.
3. BANKERS’ BANK AND SUPERVIOSRY ROLE:
Acts as a banker to other banks in the country-
(a) Custodian of cash reserves: Commercial banks must keep a certain proportion of cash reserves with the central bank
(CRR)
(b) Lender of last resort: When commercial banks fail to meet their financial requirements from other sources, they
approach Central Bank which gives loans and advances.
(c) Clearing house: Since the Central Bank holds the cash reserves of commercial banks it is easier and more convenient
to act as clearing house of commercial banks.

4. CONTROLLER OF MONEY SUPPLY AND CREDIT:

• Central Bank or RBI plays an important role during the times of economic fluctuations. It influences the money
supply through quantitative and qualitative instruments. Former refers to the volume of credit and the later refers to
regulate the direction of credit.

5. LENDER TO LAST RESORT:

• If a commercial bank fails to get financial accommodation from anywhere, it approaches the central bank as a last
resort.
• Central bank advances loans to such a bank against approved securities.
6. CUSTODIAN OF FOREIGN EXCHANGE
RESERVES:
• Another important function of central bank is the custodian of foreign exchange
reserves.
• Central Bank acts as custodian of country’s stock of gold and foreign exchange reserves.
• It helps in stabilizing the external value of money and maintaining favorable balance of
payments in the country.

7. CLEARING HOUSE FUNCTION:

• Central bank performs the functions of a clearing house.
• Let us take an example to understand this function. Supposing A receives a cheque of Rs
10,000 drawn on Bank B and Bank B receives a cheque of Rs 15,000 drawn on bank A.
• Both banks A and B have their account s with the central bank.
• The cheque of both the banks are cleared through their account s with the central bank.
CONTROL OF MONEY SUPPLY BY THE
CENTRAL BANK

The central bank adopts various measures to

control the supply of money in the economy.
These are broadly classified as:
A. QUANTITATIVE INSTRUMENTS
B. QUALITATIVE INSTRUMENTS
 QUANTITATIVE INSTRUMENTS

 I. BANK RATE POLICY:

 It refers to the rate at which the central bank lends money to commercial banks as a
lender of the last resort.
 Central Bank increases the bank rate during inflation (excess demand ) and reduces the
same in times of deflation (deficient demand )

 II. OPEN MARKET OPERATION:

 It refers to the buying and selling of securities by the central bank from /to the public
and commercial banks.
 It sells government securities during inflation and buys the securities during deflation.
QUANTITATIVE INSTRUMENTS

III. LEGAL RESERVE RATIO:

 RBI can influence the credit creation power of commercial banks by making
changes in CRR and SLR.
 CASH RESERVE RATIO: It refers to the minimum percentage of net demand and
time liabilities to be kept by commercial banks with central banks.
 Reserve Bank increases CRR during inflation and decreases the same during
deflation.
 STATUTORY LIQUIDITY RATIO : It refers to the minimum percentage of net
demand and time liabilities which commercial banks required to maintain with
themselves.
 SLR is increased during inflation and decreases the same during deflation.
 QUALITATIVE INSTRUMENTS

 MARGIN REQUIREMENTS:
 It is the difference between the amount of loan and market value of the security offered by the borrower
against the loan.
 Margin requirements are increased during inflation and decreased during deflation.

 MORAL SUASION:
 It is a combination of persuasion and pressure that central bank applies on other banks in order to get
them act in a manner in line with its policy.

 SELECTIVE CREDIT CONTROLS:

 Central bank gives direction to other banks to give or not to give credit for certain purposes to particular
sectors.
THANK YOU
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