Assessment 2 - Lesson Plan PP
Assessment 2 - Lesson Plan PP
According to Geoffrey Crowther “Money is anything that is generally accepted as a means of exchange and, at the same time, acts as a
measure and store of value.”
This definition emphasises all the three main functions of money, viz
-Medium of exchange: Anything that is generally acceptable as a means of payment or medium of exchange is known as money. Money
holds general purchasing power which can be used anytime to make payments.
-Measure of value: Money is used to measure the value of goods and services in monetary units. It acts as a convenient unit of account.
-Store of value: Money is used to store value and can be used anytime to buy goods or services. It can be stored for future use and to
make deferred payments.
Supply of Money
Money supply refers to the stock of money held by the public at a given point of time as a means of
payments and as a store of value.
- Money supply means the money held by the ‘public’ in a country. It is the money in circulation in the
country. The term public refers to all economic units such as individuals, private firms and business
institutions.
-It doesn’t include the producers of money, which means the Government, RBI and the commercial banks.
- The currency held by the government in its treasury and the money with the central and commercial banks
are not included in the supply of money.
- Money is a stock concept hence it is measured at a point in time, for example, Money in circulation in India
on 23rd December 2021.
Narrow and broad money
The total stock of money in circulation among the people at a particular point of time is called money supply. RBI
publishes figures for four alternative measures of money supply, viz. M1, M2, M3, M4. They are defined as
follows-
M1= CU+DD
M2= M1+ Savings deposits with the post office savings bank
M4= M3+ Total deposits with post office savings organisation (excluding National Savings Organisation)
Where,
‘Net’ implies that only deposits of the public held by the banks are to be included in the money supply.
M1 and M2 are known as narrow money whereas, M3 and M4 are known as Broad money.
Demand for Money
The demand for money tells us what makes people desire a certain amount of money. People want money for
various motives such as-
● Transaction motive- The value of this shows how much money people want to spend
● Liquidity motive - Value of liquidity motive shows how much money people want to save for contingencies
or emergencies.
● Speculative motive- Total value of the speculative motive shows how much money people are ready to invest
for speculation purposes.
Since money is demanded by people to conduct transactions, therefore, the value of transactions will
determine the money people want to keep. Since the quantum of transactions to be made depends on income,
a rise in the income of people will lead to a rise in demand for money.
Fig: Graph showing the speculative demand for money
What is high-powered money?
The money of the central bank is sometimes called High-powered money because the overall supply
of money in the economy depends on the amount of central bank money( Money issued by the central
bank). The central bank has direct control over the High-powered money which means that an
increase in the central bank money( currency issued) leads to more than a one-for-one increase in the
overall supply of money.
Credit creation by Commercial banks
The reserves of commercial banks(public deposits held by the commercial banks) are the secondary source of
money supply in an economy. The most important function of a commercial bank is the creation of credit.
Money supplied by commercial banks is called credit money. Commercial banks create credit by advancing loans
and purchasing securities. They lend money to individuals and businesses out of deposits accepted from the public.
However, commercial banks cannot use the entire amount of public deposits for lending purposes. They are
required to keep a certain amount as a reserve with the central bank for serving the cash requirements of depositors.
After keeping the required amount of reserves, commercial banks can lend the remaining portion of public deposits
as loans and advances.
For example- You deposit Rs. 10,000 in bank Z, which is the primary deposit of the bank. The cash reserve
requirement of the central bank is 10%. In such a case, bank Z would keep Rs. 1000 as a reserve with the central
bank and would use the remaining Rs. 9000 for lending purposes.
But banks do not advance loans or provide overdraft facilities in the form of cash. What banks actually do is that
they open a current account in the name of the borrower and allow him to withdraw the required sum by cheques
and in this way they create derivative deposits.
Thus, banks increase the volume of demand deposits without any decrease in the availability of currency with the
public. Hence, derivative deposits increase the total amount of money supply in the economy. In this way,
commercial banks can extend loans and advances by an amount that is many times more than the cash they get in
the form of primary deposits.
Policy tools to control Money Supply
Central banks have four main monetary policy tools to control the money supply:
What is M2?