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Money Supply: Functions, Forms, Demand, and Supply

March 29, 2024 640 0

Introduction

Money serves as the backbone of modern economies, facilitating transactions and enabling economic agents to exchange goods and services efficiently. While its primary role is to act as a medium of exchange, money also serves other vital functions within an economy.

  • Double Coincidence of Wants: Both parties have to agree to sell and buy each other’s commodities. 
  • In a barter system where goods are directly exchanged without the use of money, double coincidence of wants is an essential feature

 

Functions of Money

  • Money as a Medium of Exchange: Money serves as an intermediate step in an economy, eliminating the need for a double coincidence of wants. 
  • Convenient Unit of Account 
  • Universal Acceptability 
  • Store of Value
  • Dynamic in Nature: When commodity prices increase in terms of money, the purchasing power of money decreases, allowing a unit of money to purchase less of any commodity.
  • Cashless nature: Eg: Jan Dhan accounts, Aadhar-enabled payment systems, e-wallets, and National Financial Switch to promote financial inclusion.

Modern Forms of Money

  • Currency 
    • Paper Notes and Coins: It is accepted as a medium of exchange because the currency is authorized by the government of the country.  
      • Fiat Money: Currency notes and coins are called fiat money because they are backed by the promise of the Reserve Bank of India (RBI) to exchange them for goods or services of equivalent value upon presentation. 
      • They do not have intrinsic value.
      • Legal Tenders: They cannot be refused by any citizen of the country for settlement of any kind of transaction. [UPSC 2018]
    • Authority: The Government of India issues coins and notes of Rupee one. The Reserve Bank of India issues currency notes (except rupee one note) on behalf of the central government.
  • Demand Deposit: Savings and current account deposits held by the public in commercial banks are considered money because they can be accessed through cheques, which are commonly used to settle transactions
    • These deposits, known as demand deposits, are payable by the bank on demand from the account holder.
  • Term Deposit or Fixed Deposit: Deposits can be withdrawn after a stipulated time period otherwise one has to pay a penalty. 
Accounts maintained by NRI/PIO

  • Foreign Currency Non-Resident (FCNR) Account: Account can be held in any freely convertible foreign currency, exclusively as term deposits. Both the interest and principal are non-taxable and can be freely repatriated.
  • Non-Resident External (NRE) Account: Available in Indian Rupees, this account can take the form of Current, Savings, Recurring, or Fixed Deposit. The interest and principal are non-taxable and can be freely repatriated.
  • Non-Resident Ordinary (NRO) Account: Maintained in Indian Rupees, this account offers flexibility as Current, Savings, Recurring, or Fixed Deposit. While the principal and interest are taxable, repatriation is restricted.
  • Cheque: Paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been issued. 
    • Not Legal Tenders: Cheques drawn on savings or current accounts can be refused by anyone, making demand deposits not legal tenders.
  • Cryptocurrency: A digital or virtual form of currency that uses cryptography for security and operates on a decentralized network typically based on blockchain technology. 
    • Notable examples include Bitcoin, Litecoin, Monero, Dogecoin, and Bitcoin Cash.
  • The Dinesh Sharma Committee recommended a total ban on cryptocurrencies.
Bitcoins

  • Bitcoin is not tied to a bank or government and allows users to spend money anonymously
  • Anyone with a Bitcoin address can send and receive Bitcoins from anyone else with a Bitcoin address. 
  • Online payments can be sent without either side knowing the identity of the other. [UPSC 2016]
  • Non-fungible Token (NFT): Serves as a distinct cryptographic asset designed to establish and verify ownership of digital assets.
  • Central Bank Digital Currency: A digital form of a country’s official currency, issued and controlled by its central bank. 
    • It’s essentially like cash but in digital form.
  • E-rupee: A digital form of legal tender issued by the Reserve Bank of India (RBI) that can be exchanged with traditional fiat currency; 
    • Types: Retail E-rupee for general use and Wholesale CBDC for select financial institutions.

Demand and Supply of Money

  • Demand for Money: Total demand for money in an economy is composed of 
    • Transaction Demand: The amount of money required for current transactions of companies and individuals.
    • Speculative Demand: The desire to have money for the purpose of investing in assets. The former is directly proportional to real GDP and price level, whereas the latter is inversely related to the market rate of interest. [UPSC 2013]
  • Impact of Increased Money Supply: If the supply of money in the economy increases and people purchase bonds with this extra money, demand for bonds will go up, bond prices will rise and the rate of interest will decline.
    • Low Interest Rate: When the interest rate comes down, more and more people expect it to rise in the future and anticipate capital loss. 
      • Thus they convert their bonds into money giving rise to a high speculative demand for money
    • High Interest Rate: When the interest rate is very high, everyone expects it to fall in future and hence anticipates capital gains from bond-holding
      • Hence people convert their money into bonds. Thus, speculative demand for money is low.
  • Velocity of Circulation of Money: The number of times a unit of money changes hands during the unit period.
  • Liquidity Trap: Occurs when interest rates are very low, yet consumers prefer to hoard cash rather than spend or invest their money in higher-yielding bonds or other investments.
  • Aggregate Money Supply= Total currency with the public + demand deposits of the public with banks. 
    • When you withdraw Rs. 1,00,000 from the bank, it goes to the currency in hand from demand deposits in banks but it does not change the value of the money supply. [UPSC 2020]
  • Interest Coverage Ratio: It is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. [UPSC 2020]

 

Supply of Money

  • Money in a modern economy includes cash and bank deposits. These are created by the central bank and commercial banking system. Let’s have a look at them in detail. 
  • The central bank’s currency, known as high-powered money or reserve money, serves as a basis for credit creation.
  • Money supply is a stock variable that represents the total amount of money in circulation among the public at a specific time.
  • M1= currency (notes plus coins) held by the public + ‘net’ demand deposits held by commercial banks. 
    • ‘net’ implies that only deposits of the public held by the banks are to be included in the money supply. The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of the money supply.
  • M2= M1 + Savings deposits with Post Office savings banks 
  • M3= M1 + Net time deposits of commercial banks 
  • M4 =M3+Total deposits with Post Office savings organizations (excluding National Savings Certificates)
  • M1 and M2 are known as narrow money. M3 and M4 are known as broad money. 
  • M1 is the most liquid and easiest for transactions whereas M4 is the least liquid of all. M3 is the most commonly used measure of money supply. It is also known as aggregate monetary resources.
  • Currency issued by the central bank can be held by the public or by the commercial banks, and is called the ‘high-powered money’ or ‘reserve money’ or ‘monetary base’ as it acts as a basis for credit creation. 
  • Sequence of these assets in the decreasing order of liquidity: Currency > . Demand deposits with the banks > Savings deposits with the banks > Time deposits with the banks [UPSC 2013]

 

Must Read
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Upsc Notes  Upsc Blogs 
NCERT Notes  Free Main Answer Writing

 

Conclusion

  • The function of money as a medium of exchange, unit of account, and store of value is fundamental to economic transactions and the functioning of modern economies. 
  • Demand and supply of money in the money market play a crucial role in influencing interest rates, inflation levels, and overall economic stability
  • Understanding these factors is essential for policymakers, businesses, and individuals to make informed decisions and navigate the complexities of monetary policy and financial markets.
Related Articles 
Indian Economy: Evolution Basics of Money
Banks in India Financial Market
Indian Insurance Sector Financial Inclusion

 

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 Final Result – CIVIL SERVICES EXAMINATION, 2023.   Udaan-Prelims Wallah ( Static ) booklets 2024 released both in english and hindi : Download from Here!     Download UPSC Mains 2023 Question Papers PDF  Free Initiative links -1) Download Prahaar 3.0 for Mains Current Affairs PDF both in English and Hindi 2) Daily Main Answer Writing  , 3) Daily Current Affairs , Editorial Analysis and quiz ,  4) PDF Downloads  UPSC Prelims 2023 Trend Analysis cut-off and answer key

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 Final Result – CIVIL SERVICES EXAMINATION, 2023.   Udaan-Prelims Wallah ( Static ) booklets 2024 released both in english and hindi : Download from Here!     Download UPSC Mains 2023 Question Papers PDF  Free Initiative links -1) Download Prahaar 3.0 for Mains Current Affairs PDF both in English and Hindi 2) Daily Main Answer Writing  , 3) Daily Current Affairs , Editorial Analysis and quiz ,  4) PDF Downloads  UPSC Prelims 2023 Trend Analysis cut-off and answer key

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AVAILABLE FOR DOWNLOAD SOON
UDAAN PRELIMS WALLAH
Comprehensive coverage with a concise format
Integration of PYQ within the booklet
Designed as per recent trends of Prelims questions
हिंदी में भी उपलब्ध
Quick Revise Now !
UDAAN PRELIMS WALLAH
Comprehensive coverage with a concise format
Integration of PYQ within the booklet
Designed as per recent trends of Prelims questions
हिंदी में भी उपलब्ध

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