WELCOME

MONEY

zzzzEMERGENCE OF MONEY

Exchange of goods for goods is called barter system.

Barter system suffered from many drawbacks, such as :

Lack of double coincidence of wants Lack of common measure of value Lack of divisibility Difficulty in storing wealth Difficulty in borrowing and lending

WHAT IS MONEY????

According to G. Crowther, “ Money is anything that is generally accepted as a medium of exchange and at the same time acts as a measures and as a store of value”.

Kinds of money:

Paper money

Metallic money

Private bank money

Primary functions

Medium of exchange Measurement of value

Secondary functions

Store of value

Transfer of value

Standard of deferred payment

Contingent functions

Distribution of national income Basis of credit and credit creation Guarantee of solvency Maximization of satisfaction Bearer of option

Keynesian theory of demand for money

Keynesian theory of the demand for money was first formulated by Keynes in his well-known book, The Genera’ Theory of Employment, Interest and Money (1936). It has developed further by other economists of Keynesian persuasion. Keynes stated that people’s demand for money does not mean the actual cash balances people hold , but the amount of cash balances they WANT TO HOLD” .In understanding Keynes’ theory two questions need to separate.

One is why money is demanded?

Other is what are the key determinants of demand for money?

Demand for money

Money is the most liquid form of asset. The demand for money refers to the total money demanded by the people in the form of cash for various purposes. According to Keynes, This theory is also known as “Liquidity Preference”.

The demand for money arises because of the following three motivates:

Transaction motive

Precautionary motive

Speculative motive

Transaction motive

Holding cash to meet daily needs is called Transaction motive the need for holding cash arises because there exist a time-gap between receipt of income and the consumption expenditure.

Usually, people receive income at certain intervals of time such as a week, a month, etc,. which is to be consumed throughout the period till the next receipt.This demand for money is a positive function of income.

precautionary motive

The demand for money to meet this unforeseen and unexpected expenses in known as precautionary demand for money.

Like the transaction demand for money, precautionary demand for money is also a positive function of money.

Emand for money Speculative motive

The speculative demand for money refers to the demand for the money that people hold as idle cash balance to speculate with the aim of earning capital gains and profits.

Keynes demonstrated that there is a inverse relationship between the rate of interest and speculative demand for money.

Keyne’s theory of demand for money

Transaction motive

Precautionary motive

Speculative motive

Cash needed to conduct day-day

transactions

Cash needed to meet unforseen

contingencies

Hold of cash to achieve capital

gains

Time gap between receipts and

payments

Uncertainity about future receipts and

expenditure

Uncertainity of future market rate of interest

Mt is income determined and interest inelastic

Mp is income determined and interest inelastic

Ms is income determined and interest elastic

Graphical representation of keyne’s theory

Total demand for money = Mt + Mp + Ms

Where, Mt = f(y), as income increases, demand transaction motive increases

Mp = f(y), as income increases, demand for precautionary motive

increases. Ms = f(i), as interest rates increases, demand for speculative motive

decreases and vice-versa.

Liquidity trap

The concept of liquidity trap was also an outcome of Keynes's thought. It is an unfavorable conditions of an economy in which the monetary authority cannot do anything. As mentioned above speculative motive of demand for money is depending on the market rate of interest. At a lower rate of interest the bond price will raise. So, People demand money increases. But in an unfavorable economic condition a sharp reduction in the Interest rates will lead to a trap which is popularly called by economist’s the “liquidity trap”. This can be shown in the .following figure:

Supply of money

Supply of money refers to aggregate stock of money i.e.,. Currency notes and coins held by the people in the country at a particular point of time. The monetary authority of an economy undertakes the task of issuing currency notes and coins. In India the monetary authority and RBI together forms the monetary authority. Currency notes are issued by RBI and coins are issued by monetary authority. They together known as High Power Money.

The stock of money has the following two major components: The currency component The deposit component

Importance of money supply

Money supply plays a crucial role in the determination of price level and interest level.

Growth of money supply helps in acceleration of economic development and price stability

There must be a controlled expansion of money supply i.e., no inflation or deflation in the economy.

The supply of money depends on monetary base and reserve ratio, But not on the interest rate, so the supply of money is vertical.

Measures of money

Since, April 1977, RBI has adopted four concepts of money supply . i. e, M1,M2,M3,M4.

M1 : It includes with money public, demand deposits and other deposits with RBI. It is termed as narrow money. It is measured as follows:

M1 =C+DD+ODWhere,

C= Represents currency with publicDD= Represents demand deposits with

commercial banksOD= Represents other deposits with RBI

M2: It includes all the components of M1 and savings deposits with the post office. It is measured as follows:

M2 = M1 + POSBDWhere,

POSBD= Represents post office savings bank deposits.

M3: It includes all the components of M1 along with the time deposits of all banks. It is “ Broad money” concept. It is measured as follows:

M3 = M1 + TDwhere,

TD = Represents Time deposits with all banks.

M4: It includes all the components of M3 and total deposits with post office savings deposits( excluding National Savings Certificates) . It is measured as follows:

M4 = M3 + TOPDWhere,

TOPD = Represents total post office deposits (excluding NSCs)

Liquidity and ranking

NAME TYPE LIQUIDITY

M1 Narrow money Highest

M2 Narrow money Less than M1

M3 Broad money Less than M2

M4 Broad money Lowest Liquidity

New measures of money supply

Initially for the last quarter of 20th century, RBI used to calculate money supply and monetary aggregates in four forms namely, M1, M2, M3, M4. But thereafter, RBI working group on money supply has modified the parameters of measuring money supply. Thus, at present there exists only three monetary aggregates. i.e., NM1, NM2, NM3.

NM1=currency with the public + demand deposits with the banking system + other deposits with the RBI.

NM2= NM1 + Short term time deposits of residents (including and up to the contractual maturity of the year)

NM3= NM2 + long term deposits f residents + call/ term funding from financial institutions.

Narrow money

Narrow money refers to coins and currency notes with public, demand drafts with bank and other deposits with RBI. It is represented in M1 or NM1. The money which is fully liquid and available whenever people need is called narrow money.

The narrow definition of money can be represented as:

Narrow money = C + DD + OD

where, C= Represents narrow definition of money

DD= Represents currency held by the publicOD= Represents other deposits with RBI

Broad money

Broad money refers to the money that is held in the form of savings and Net Time Deposits besides the currency and demand deposits. It is the money which is represented by M3 or NM3. IT includes both full liquid and less liquid money.

The broad money can be represented as:

Broad money= C + DD + SD + TD

Where, C= Represents currency held by the public

DD= Represents demand deposits held by the commercial banks SD= Represents saving deposits of the public held with post office TD= Represents Time deposits with the commercial banks.

Presented by

Vishwaroopa YadavVilmaVidyaNeiniJatin SakariaPraveen Kumar

Any Questions ??????????