Revision: Introductory Macroeconomics >> Money and Banking Economics Commerce (English Medium) Class 12 CBSE

CRR = (Cash Reserves / Total Deposits) × 100

\[\text{Money Multiplier}=\frac{1}{\text{Cash Reserve Ratio}}\]

\[M_d^T=kPY\]

where 

Y = real GDP

P = general price level (GDP deflator), so PY = nominal GDP.

Conclusion:
Transaction demand for money increases with an increase in real GDP (Y) and the general price level (P).

\[M_d^T=kT\]

where

\[M_d^T\] = transaction demand for money,
T = total value of nominal transactions in the period,
k = positive fraction of transaction value held as money.

\[\frac{1}{k}M_d^T=T\quad\Rightarrow\quad vM_d^T=T\]

where,

\[v=\frac{1}{k}\] is the velocity of circulation of money (number of times each unit of money changes hands in the period).

\[M_d^T=kPY\]

where k>0, PP = price level, Y = real GDP.

\[M_d^S=\frac{r_\max-r}{r-r_\min}\]

where
\[M_d^S\] = speculative demand for money,
r = current market rate of interest,
r_max⁡ = upper limit of r,
r_min⁡ = lower limit of r.
As r falls towards r_min⁡, \[M_d^S\]→∞ (liquidity trap).

\[\boxed{M_d=M_d^T+M_d^S}\]

or

\[\boxed{M_d=kPY+\frac{r_{max}-r}{r-r_{min}}}\]

\[M_d=M_d^T+M_d^S\quad\Rightarrow\quad M_d=kPY+\frac{r_\max-r}{r-r_\min}\]

• 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. 

• 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.

• Demand for money depends on income (transactions) and rate of interest.
• Higher income → higher demand for money; higher interest rate → lower demand for money.
• Money supply consists of cash and bank deposits.
• Central Bank (RBI) issues currency and controls money supply (high-powered money).
• Commercial banks create money through deposit and credit creation.

• Money is created by banks when they give loans and advances to the public.
• Public deposits a part of its cash with commercial banks; banks use major part of these deposits for lending.
• Banks operate with a central bank (RBI) and hold a part of deposits as reserves with it.
• A bank’s balance sheet records its assets (reserves and loans) and liabilities (deposits).
• Deposits are liabilities because the bank must repay them to depositors on demand.
• Reserves include cash in vault plus deposits with RBI, while loans are amounts lent to customers.

• CRR limits the amount of credit banks can create.
• Higher CRR → Lower credit creation and money supply.
• Lower CRR → Higher credit creation and money supply.
• Loans become deposits, leading to multiple rounds of credit creation.
• Money Multiplier = 1 / CRR.

• RBI is the sole issuer of currency and the Lender of Last Resort.
• Monetary tools are Quantitative (CRR, Bank Rate, OMO) and Qualitative (moral suasion and margin requirements).
• Higher CRR reduces bank lending and decreases money supply.
• OMO: RBI buys bonds to increase money supply and sells bonds to decrease it.
• Repo injects liquidity; Reverse Repo absorbs liquidity.
• Higher Bank Rate reduces money supply; lower Bank Rate increases it.

• Money is the most liquid asset among all assets.
• There is an opportunity cost to holding money - foregone interest from bonds or other assets.
• The demand for money is called liquidity preference.
• People hold money due to different motives, primarily the transaction motive and the speculative motive.

• Transaction motive means holding money for day-to-day transactions.
• People hold cash because income receipts and expenditures occur at different times.
• Transaction demand is generally a fraction of total transactions.
• Velocity of circulation measures how many times a unit of money changes hands during a period.
• T is a flow variable, Mdᵀ is a stock variable, and v has a time dimension.
• Transaction Demand Formula: Mdᵀ = kT
• Velocity Formula: v = 1/k or vMdᵀ = T
• Modified Formula: Mdᵀ = kPY; transaction demand rises with real GDP (Y) and the general price level (P).

• Bonds are tradable securities promising future monetary returns.
• Bond price = Present Value (PV) in equilibrium.
• Bond price and interest rate are inversely related.
• Rising interest rates cause capital loss on bonds.
• Speculative demand for money depends on expectations and is inversely related to interest rates.
• A liquidity trap occurs at rminr_{min}rmin​, where speculative demand becomes infinite.
• Total money demand = Transaction Demand + Speculative Demand.

• Money includes currency notes, coins and demand deposits.
• RBI issues currency notes; Government of India issues coins.
• Demand deposits are payable on demand, while time deposits have a fixed maturity.
• Currency has little intrinsic value but possesses purchasing power due to the guarantee of the issuing authority.
• Currency is fiat money and legal tender; cheques are not legal tender.

• Money supply is a stock variable: total stock of money with the public at a point of time.
• RBI uses four measures: M1, M2, M3, M4.
• M1 = CU + DD; 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 organisations (excluding NSCs).
• CU = currency with the public; DD = net demand deposits of the public; interbank deposits are excluded.
• M1, M2 = narrow money; M3, M4 = broad money.
• Liquidity: M1 most liquid, M4 least; M3 is most commonly used and called aggregate monetary resources.

• Demonetisation = withdrawal of legal tender status of certain currency notes.
• 8 Nov 2016: ₹500 and ₹1,000 notes demonetized; about 86% of cash invalid.
• Main aims: black money, corruption, fake notes, and terror funding.
• Seen as a tax administration step and move to a less-cash, digital economy.
• Effects: cash crunch at first, then higher deposits, more digital payments, higher tax collection, lower real estate prices.