- Facilitates Consumption and Production: Money gives consumers purchasing power and helps producers decide what and how much to produce based on prices and demand.
- Removes Difficulties of Barter System: Money eliminates problems like double coincidence of wants, indivisibility of goods, and lack of a common measure of value.
- Helps in Distribution of Income: Payments to factors of production such as wages, rent, interest, and profit are made easily in terms of money.
- Promotes Capital Formation: Savings are made in money form and mobilised by banks and financial institutions for investment and economic growth.
- Supports Trade and Exchange: Money facilitates smooth internal and international trade by acting as a medium of exchange and basis of price mechanism.
- Important for Public Finance and Social Welfare: Government collects revenue and incurs expenditure in money, and social welfare and standard of living are measured in monetary terms.
Definitions [6]
Definitions: Money
- Prof. Crowther: "Money is anything that is generally acceptable as a means of exchange and at the same time acts as a measure and store of value."
- Prof. Walker: "Money is what money does" (Shows money is defined by its functions).
- Robertson: "anything which is widely accepted in payments for goods or in discharge of other kinds of business obligations.”
- “Anything which is commonly used and generally accepted as a medium of exchange or as a standard of value.” — Dr. Kent
- G.D.H. Cole: "Money is anything which is habitually and widely used as a means of payment and is generally accepted in the settlement of debts.”
Definition: Barter System
“The direct exchange of economic goods, one for another.” — Chandler
Definition: Banking
“Ordinary banking business consists of changing cash for bank deposit and bank deposit for cash, transferring bank deposit from one person to another, giving bank deposit in exchange for government bonds, the recurring promises of businessmen to repay and so forth.” — Prof. Sayer’s
Define the following concept.
Open Market Operation
Open market operations refer to the sale and purchase of government and other approved securities by central bank in the money and capital markets.
Open Market Operations (OMOs) are employed by Central Banks, such as the RBI, to control the money supply. Buying and selling government bonds on the open market changes liquidity, interest rates, and the economy. Central Bank purchases of securities increase market liquidity and lower interest rates. Selling assets reduces market liquidity and raises interest rates.
Definitions: Central Bank
- "A bank which constitutes the apex of the monetary and banking structure of the country." — De Kock
- "A central bank is "The bank in any country is one which has been entrusted the duty of regulating the volume of currency and credit in that country." — Bank for International Settlements
Definitions: Commercial Banks
- “A bank collects money from those who have it to spare or who are saving it out of their incomes and it lends this money to those who require it.” — Crowther
- “Bank means accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft or otherwise.” — According to Indian Companies Act, 1949
- Banking Regulation Act of 1949: “Banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, demand draft, order or otherwise.”
- Prof. Cairncross: “A bank is a financial intermediary, a dealer in loans and debts.”
Key Points
Key Points: Concept of Money
- Money eliminates barter system problems by providing a common medium of exchange.
- Three main functions: medium of exchange, measure of value, store of value.
- Must be generally acceptable to function as money.
- Modern economy completely depends on money for smooth transactions.
- Digital payments are the newest evolution in money's history.
Key Points: Barter System
The barter system’s limitations—double coincidence of wants, no standard value, storage issues, indivisibility, and deferred payments—led to the invention of money, which streamlined trade and economic growth.
Key Points: Modern Form of Money
- Coins = metallic money; token money; limited legal tender; issued by Government of India
- Currency Notes = paper money; issued only by RBI; inconvertible; unlimited legal tender; also token money
- Deposit Money = bank deposits against which cheques are drawn; safe and convenient; cheques are NOT legal tender
- Legal Tender = money that cannot be refused by law; coins are limited legal tender; notes are unlimited legal tender
- Credit Cards = NOT money; create a loan, not a payment; real money still settles every credit card transaction
- Token Money = face value > intrinsic value (applies to both coins AND notes)
- Fiat Money = value declared by the government; backed by trust and law, not gold or silver
Key Points: Functions of Money
- Money removes barter difficulties and supports smooth exchange.
- Primary functions: medium of exchange and measure of value/unit of account.
- Secondary functions: standard of deferred payments, store of value and transfer of value.
- Contingent functions: maximise utility and profit, distribute national income, support credit and provide liquidity.
- Overall, money is “a medium, a measure, a standard, a store” with transferability added by some authors.
Key Points: Importance of Money
Key Points: Supply of Money
- Money supply = the public's stock of money at a point in time; excludes government, RBI, and bank holdings.
- Two components: Currency (fiat money, legal tender) and Demand Deposits (bank money, not legal tender).
- RBI uses 4 measures: M₁ (narrowest, most liquid) → M₂ → M₃ → M₄ (broadest, least liquid).
- M₁ captures money purely as a medium of exchange; M₃ adds the store-of-value dimension (time deposits).
- M₃ is the most widely monitored by the RBI and macroeconomic policymakers.
- High-Powered Money (M₀) is the foundation — a small increase in M₀ leads to a multiplied increase in total money supply via the money multiplier.
- India's currency share (~50%) in the money supply is far higher than in developed countries like the USA (~18%), reflecting lower banking penetration.
Key Points: Inflation
- Inflation = persistent + appreciable + general rise in prices — all three must be present.
- A 2–3% annual inflation is healthy; it becomes a problem only when excessive.
- Demand-Pull Inflation = too much demand; too little supply → prices rise.
- Cost-Push Inflation = rising costs (wages/oil/monopoly power) → producers raise prices.
- Three sub-types of cost-push: wage-push, profit-push, and supply shock (oil shock).
- The inflation rate measures the % increase in average prices year over year.
Key Points: Types of Bank
- Banks are financial intermediaries — they connect savers and borrowers, fuelling the economy.
- RBI is the apex bank of India — it regulates all other banks, issues currency, and manages monetary policy.
- Commercial banks (such as SBI and HDFC) are the most common — they serve the general public for everyday banking needs.
- Cooperative and RRBs serve rural India and weaker sections, providing affordable credit.
- EXIM Bank (est. 1982) exclusively supports India's international trade through long-term finance.
- Development Banks like SIDBI and NABARD drive industrial and agricultural growth by providing long-term capital.
- Modern additions — Small Finance Banks and Payments Banks — ensure financial inclusion for India's last-mile population.
Key Points: Banking > Functions of Commercial Bank
- Accept Deposits – Main source of funds: Demand Deposits (Current/Savings Accounts) & Time Deposits (Fixed/Recurring Deposits)
- Grant Loans & Advances – Cash Credit, Overdraft, Term Loans, Bill Discounting (banks profit from interest spread)
- Cheque System – Safe payment method using cheques (principal business payment tool)
- Transfer of Funds – Fast/safe money transfer via drafts, pay orders, mail/telegraphic transfers (essential for commerce)
- Credit Creation – Banks multiply money: loans create new deposits (Initial Deposit × 1/CRR formula)
- Financing Trade – Bill discounting + short-term trade loans (facilitates internal/external trade)
- Foreign Exchange & Utility Services – Currency exchange + lockers, travel cheques, mobile banking, agency functions
Key Points: Central Bank
- The central bank is the highest authority in the banking system. It controls, regulates and supervises all banks and manages the country’s monetary system.
- It formulates and implements monetary policy to control inflation, deflation, and overall credit in the economy.
- It acts as a banker, adviser and agent to the government, and also works as a “banker’s bank” by guiding and supporting commercial banks.
- The central bank has the sole authority to issue currency (except small coins/notes in some cases), ensuring a uniform and reliable money supply.
- It supports economic growth by promoting banking, developing financial institutions, managing foreign exchange, and helping priority sectors.
Key Points: Methods of Credit Control
- Credit control = methods used by the central bank to regulate money and credit.
- Two types: Quantitative and Qualitative.
- Quantitative → controls total credit (e.g., Bank Rate, CRR, OMO).
- Qualitative → controls use of credit (e.g., rationing, moral suasion).
- Difference: Quantitative = general control, Qualitative = selective control.
Key Points: Quantitative Methods
Quantitative methods control the overall volume of credit in the economy without discrimination.
Bank Rate / Repo Rate:
- ↑ Rate → borrowing becomes costly → credit contracts (controls inflation)
- ↓ Rate → borrowing becomes cheaper → credit expands (controls deflation)
Open Market Operations:
- Sale of securities → reduces bank reserves → less credit
- Purchase of securities → increases bank reserves → more credit
CRR & SLR:
- ↑ CRR/SLR → banks lend less
- ↓ CRR/SLR → banks lend more
Key Points: Commercial Banks
- Commercial banks are profit-seeking intermediaries connecting savers and borrowers.
- Their primary functions are accepting deposits and granting loans.
- India has 89 scheduled commercial banks divided into PSBs, RRBs, Private Banks, and Foreign Banks.
- Nationalisation in 1969 and 1980 expanded banking access to rural and priority sectors.
- SBI is India's largest bank — 25% market share, 45 crore customers, top 5 globally.
- RRBs serve rural India at lower interest rates and are the backbone of rural credit.
- Private and foreign banks drive technology, innovation, and competition in banking.
- Commercial banks are regulated by the Reserve Bank of India (RBI) and governed by the Banking Regulation Act, 1949.
Concepts [40]
- Introduction to Money and Inflation
- Concept of Money
- Features of Money
- Barter system
- Difficulties of Barter System of Exchange
- Evolution of Money
- Qualities of Good Money
- Modern Forms of Money
- Functions of Money
- Primary Functions
- Secondary Functions
- Contingent Functions
- Importance of Money
- Supply of Money
- Measures of Money Supply
- Inflation
- Types of Inflation
- Introduction to Banking System
- Types of Bank
- Functions of Commercial Bank
- Central Bank
- Functions of Central Bank
- Methods of Credit Control by the Central Bank
- Quantitative Methods of Credit Control by the Central Bank
- Qualitative Methods of Credit Control by the Central Bank
- Difference Between the Central Bank and the Commercial Banks
- Role of Banks in the Economy
- Indian Monetary System
- Constitutents of Money Supply
- Reserve Bank of India's Approach of Money Supply
- Factors Affecting Money Supply
- Commercial Banks
- Process of Credit Creation by Commercial Banking System
- Factors Affecting Credit Creation
- High Powered Money
- Classification or Structure of Commercial Banks in India
- Components of Money Supply
- Evolution of Central Bank
- Need for a Central Bank
- Importance of Central Bank
