- In November 2016, ₹500 and ₹1000 notes were demonetised.
- Aim: curb black money, corruption, fake currency, terrorism.
- Caused short-term cash crunch and disruption.
- Led to better tax compliance and more money in banks.
- Encouraged digital and formal transactions.
Definitions [4]
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 widely accepted in payment for goods" (Focuses on exchange function).
- “Anything which is commonly used and generally accepted as a medium of exchange or as a standard of value.” — Dr. Kent
Legal Definition of Money
"Money is anything which has the legal power to act as a medium of exchange and to discharge debt."
Under this definition, only items backed by government authority — currency notes and coins — qualify as money. In the words of Robertson: "Money is anything which is widely accepted in payment for goods or in discharge of other kinds of business obligations."
Functional Definition of Money
Gowther defines money as, "Money is anything that is generally acceptable as a means of exchange and at the same time, acts as a measure and as a store of value".
Definition: Money
"Money is a matter of four functions — A Medium, a Measure, a Standard, and a Store."
Formulae [6]
Transaction demand for money
\[M_d^T=kT\]
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.
Velocity form of the same identity
\[\frac{1}{k}M_d^T=T\quad\Rightarrow\quad vM_d^T=T\]
where \[v=\frac{1}{k}\] is the velocity of circulation of money (number of times each unit of money changes hands in the period).
Transaction demand as a function of nominal GDP
\[M_d^T=kPY\]
where Y = real GDP and P = general price level (GDP deflator), so PY = nominal GDP.
Speculative demand for money
\[M_d^S=\frac{r_\max-r}{r-r_\min}\]
where
\[M_d^S\] = speculative demand for money,
r = current market rate of interest,
rmax = upper limit of r,
rmin = lower limit of r.
As r falls towards rmin, \[M_d^S\]→∞ (liquidity trap).
Transaction demand
\[M_d^T=kPY\]
where k>0, PP = price level, Y = real GDP.
Aggregate demand for money
\[M_d=M_d^T+M_d^S\quad\Rightarrow\quad M_d=kPY+\frac{r_\max-r}{r-r_\min}\]
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: Functions of Money
- Medium of Exchange & Measure of Value: Money is used to buy and sell goods and services and to express prices, income, and expenditure in a common unit.
- Standard of Deferred Payments & Store of Value: Money makes future payments (loans, wages) easy and allows saving for future needs.
- Transfer of Value & Liquidity: Money helps transfer value across persons and places and is the most liquid form of wealth.
- Basis of Credit & Economic Measurement: Money forms the base of bank credit and helps measure national income and other macroeconomic variables.
Key Points: Demand for Money and Supply of Money
- 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.
Key Points: Money Creation by Banking System
- Banks create money by lending, as all depositors do not withdraw money at the same time.
- When a bank gives a loan, it creates a new deposit, increasing money supply.
- Assets of a bank = Reserves + Loans.
- Liabilities of a bank = Deposits.
- Money supply (M1) = Currency + Deposits; with no currency, M1 equals total deposits.
Key Points: Limits to Credit Creation and Money Multiplier
- Banks cannot create unlimited credit due to reserve requirements set by RBI.
- Cash Reserve Ratio (CRR) is the minimum percentage of deposits banks must keep as cash reserves.
- Higher CRR → lower credit creation; lower CRR → higher credit creation.
- Money Multiplier = 1 / CRR, shows how much total deposits can be created.
- With CRR = 20%, ₹100 reserves can create ₹500 deposits (multiplier = 5).
Key Points: Policy Tools To Control Money Supply
- RBI controls money supply and acts as the lender of last resort to banks.
- Quantitative tools: CRR, Bank Rate, Open Market Operations (OMO).
- Higher CRR or Bank Rate reduces lending and decreases money supply.
- Open Market Operations: RBI buys bonds → money supply increases; sells bonds → money supply decreases.
- Repo and Reverse Repo rates are key modern tools of RBI’s monetary policy.
Key Points: Various Measures of Supply of Money
- Money includes currency notes, coins, and demand deposits (savings & current accounts).
- Currency notes are issued by RBI and coins by the Government of India.
- Demand deposits are payable on demand and used for transactions; time deposits are not money.
- Currency has value due to government/RBI guarantee, not intrinsic value (fiat money).
- Currency is legal tender, but cheques are not legal tender.
Key Points: Demonetisation
Important Questions [4]
- Explain the ‘Unit of Accounts’ Function of Money. How Has It Solved the Related Problem Created by Barter?
- Explain the Significance of 'Medium of Exchange' Function of Money
- Explain the 'Medium of Exchange' Function of Money. How Has It Solved the Related Problem Created by Barter?
- ‘Money is an asset which can be stored for use in future. In the light of given statement, identify the function of money.
Concepts [12]
- Concept of Money
- Functions of Money
- Demand for Money and Supply of Money
- Money Creation by Banking System
- Limits to Credit Creation and Money Multiplier
- Policy Tools To Control Money Supply
- Demand and Supply for Money : A Detailed Discussion
- The Transaction Motive
- The Speculative Motive
- Various Measures of Supply of Money
- Legal Definitions: Narrow and Broad Money
- Demonetisation
