Money Supply: Functions, Forms, Demand, and Supply

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.

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• Term Deposit or Fixed Deposit: Deposits can be withdrawn after a stipulated time period otherwise one has to pay a penalty. 

• 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.

• 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]

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.

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.

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