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Semester 5: MONETARY ECONOMICS
Money: Definition, Forms, Functions, Supply (M1-M4), Crypto Currencies
Money
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts within a given country or socioeconomic context. It serves as a medium of exchange, a unit of account, and a store of value.
Money can take several forms, including currency (coins and paper money), bank deposits, and digital money (electronic funds). Each form has its own characteristics and uses within the economy.
The primary functions of money include acting as a medium of exchange, facilitating transactions, serving as a unit of account to measure value, and providing a store of value to preserve purchasing power over time.
M1 includes the most liquid forms of money, such as cash and checking deposits.
M2 includes M1 as well as savings accounts, time deposits, and other near money assets.
M3 includes M2 along with larger liquid assets like institutional money market funds.
M4 includes all the money supplied in the economy along with government securities and other forms of money.
Cryptocurrencies are digital or virtual currencies that utilize cryptography for security. They operate on decentralized networks based on blockchain technology, offering an alternative to traditional currency systems. Bitcoin and Ethereum are notable examples.
Demand for Money: Classical, Keynesian, Baumols Inventory, Tobins Portfolio, Friedmans Theory
MONETARY ECONOMICS
B.A.
ECONOMICS
5
PERIYAR UNIVERSITY
Core Course - IX
Demand for Money
Classical Theory of Money Demand
The Classical Theory suggests that the demand for money is determined by the quantity of goods and services produced in an economy. It emphasizes the transactional motive for holding money, where money is needed for everyday transactions.
Keynesian Theory of Money Demand
Keynesian economics introduces speculative and precautionary motives for holding money. According to Keynes, individuals hold money not just for transactions but also to manage uncertainty and to take advantage of investment opportunities.
Baumol's Inventory Theory
Baumol's Inventory Theory suggests that individuals manage their cash balances by balancing the liquidity of money with the opportunity cost of holding it. This model considers the trade-off between holding cash and investing in interest-bearing assets.
Tobin's Portfolio Theory
Tobin's Portfolio Theory expands on the demand for money by suggesting that individuals allocate their assets between money and other financial instruments to maximize utility. The model takes into account the trade-off between risk and return.
Friedman's Theory of Money Demand
Friedman's approach incorporates a broader view of the demand for money, linking it to wealth, income, and interest rates. He argues that individuals' demand for money is influenced by social and economic factors beyond mere transactional needs.
Monetarism Vs Keynesianism, Determinants of Money Supply, Money Multiplier
Monetarism Vs Keynesianism, Determinants of Money Supply, Money Multiplier
Monetarism
Monetarism emphasizes the role of governments in controlling the amount of money in circulation. The key figure is Milton Friedman, who argued that variations in the money supply have major influences on national output in the short run and the price level over longer periods. Monetarists believe that managing the money supply is crucial for controlling inflation and that monetary policy is more effective than fiscal policy in stabilizing the economy.
Keynesianism
Keynesianism is based on the ideas of John Maynard Keynes, who argued that total spending (aggregate demand) is the primary driver of economic growth and employment. Keynesians believe that during economic downturns, increased government spending and lower taxes can help stimulate demand and pull the economy out of recession. They advocate for active government intervention in the economy to manage demand.
Determinants of Money Supply
The money supply in an economy is influenced by several factors, including central bank policies, reserve requirements, demand for loans, and public confidence in the banking system. The central bank can influence the money supply through open market operations, changing interest rates, and adjusting reserve requirements for banks. Increased demand for loans can also lead to an increase in the money supply as banks lend more.
Money Multiplier
The money multiplier is a key concept in banking that measures the maximum amount of money that can be created in the banking system for a given amount of reserves. It is defined as the inverse of the reserve ratio. For example, if the reserve ratio is 10%, the money multiplier is 10, meaning that for every one unit of currency held in reserve, up to ten units can be created in the economy. This illustrates how banks can expand the money supply through lending.
Commercial Banks: Credit Creation, RBIs role, Nationalisation, Narasimhan Report
Commercial Banks: Credit Creation, RBI's Role, Nationalisation, Narasimhan Report
Credit Creation by Commercial Banks
Commercial banks play a vital role in the economy by creating credit through the process of accepting deposits and providing loans. They utilize the fractional reserve banking system, where they are required to keep only a fraction of deposits as reserves, allowing them to lend out the remainder. This mechanism facilitates an increase in the money supply within the economy. The credit created can lead to increased investments and consumer spending, thereby boosting economic growth.
Role of the Reserve Bank of India (RBI)
The RBI acts as the central bank of India, overseeing and regulating the commercial banking sector. Its responsibilities include formulating monetary policy, managing currency and credit, supervising financial institutions, and ensuring monetary stability. The RBI also sets the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), which influence how much money banks can lend. By adjusting interest rates and using tools like Open Market Operations, the RBI regulates the money supply and controls inflation.
Nationalisation of Banks
The nationalisation of banks in India took place primarily in 1969 and 1980 to align the banking sector with national economic goals. The government aimed to extend banking services to rural and underprivileged areas, control credit allocation, and enhance financial inclusion. Nationalisation expanded the reach of banks, improved control over credit policy, and supported various developmental programs directed at economic growth.
Narasimhan Report
The Narasimhan Committee, established in 1991, played a crucial role in reforming India's banking sector. The committee's recommendations focused on deregulation, increasing competition, enhancing the efficiency of banks, and improving the health of the financial system. It suggested measures such as the establishment of asset management companies, restructuring of public sector banks, and enhancing risk management practices. The report laid the foundation for subsequent reforms that transformed India's banking landscape.
Monetary Stability and Central Bank: Inflation/Deflation, Central Bank Functions, RBI, Monetary Policy in India
Monetary Stability and Central Bank
Overview of Monetary Stability
Monetary stability refers to a situation where there is a stable purchasing power of money. It is crucial for economic growth and stability, as it influences consumer and investor confidence.
Inflation and Deflation
Inflation is the rate at which the general level of prices for goods and services rises, eroding purchasing power. Deflation is the decrease in general price levels, leading to increased purchasing power. Both phenomena affect monetary stability and the economy.
Functions of Central Banks
Central banks have several key functions including regulating the money supply, controlling inflation, managing foreign exchange and gold reserves, and acting as a lender of last resort. They implement monetary policy to achieve economic goals.
Role of RBI in India
The Reserve Bank of India (RBI) is the central bank of India, responsible for managing monetary stability, issuing currency, and supervising the banking system. The RBI plays a critical role in formulating and implementing monetary policy.
Monetary Policy in India
Monetary policy in India is aimed at controlling inflation, managing liquidity, and ensuring economic growth. The RBI utilizes various tools such as repo rate adjustments, cash reserve ratio, and open market operations to influence economic activity.
