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Monetary System - Economics, UPSC, IAS. Notes | Study Indian Economy (Prelims) by Shahid Ali - UPSC

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Monetary System

Money

What is money?

  1. Which act as a unit of value
  2. Which act as a medium of exchange
  3. Which act as a store of value

Legal Definition

Which have the legal tender power (power to discharge debts)

Fiat Money

Our currency is fiat money because it serves as money on the fiat (order) of the government.

Functional definition

All things which can perform functions that money does

Classification of money

  1. Full Bodied Money
  2. Representative Money

Indian Monetary System

  • India is on a paper currency standard
  • Paper currency has unlimited legal tender
  • All coins and one rupee note are issued by Government of India. That’s why one rupee note doesn’t bear the signature of Governor of RBI. It bears the signature of Finance Secretary, Government of India.
  • India’s currency is unconvertible i.e. paper currency is not convertible into gold
  • Rupee was first minted in India during the reign of Sher Shah Suri around 1542.
  • India became a member of International Monetary Fund (IMF) in 1947, and exchange value of rupee came to be fixed by IMF standards.

Demonetization of Currency in India :

  • It refers to the withdrawal of currency from circulation which is done to Ambush Black Market.

Indian Devaluation of Currency:

  • Refers to reducing value of the Indian rupee in comparison to the leading currencies in the World Market.

First Devaluation: In June 1949 (by 30.5%) (Finance Minister: Dr. John Madiai).

Second Devaluation: In June 1966 (by 57%) (Finance Minister: Sachindra Chaudhry).

Third Devaluation: On July 1, 1991 (by 9%) (Finance Minister: Dr. Manmohan Singh).

Fourth Devaluation: On July 3, 1991 (by 11%) Finance Minister: Dr. Manmohan Singh).

  • The Basic Objective of devaluation was to reduce deficits in balance of trade by making exports relatively cheap and imports costly.

Money Supply in India :

  • Money supply has been increasing continuously with the rise in prices, through the increase rate in money supply has varied from year to year.
  • On the recommendations of the second working group on money supply, RBI introduced a series of money stock measures in India since 1970 – 71, which are :

M1 = Money with the Public (currency notes and coins) + Demand deposits of banks (on current and saving bank accounts) + Other demand deposits with RBI.

M2 = M1 + saving bank deposits with Post-offices. M3 =M1 + Term deposits with the Bank.

M4 =M3 + All deposits of Post-offices saving organisation excluding NSCs

  • M1 measure represents the most liquid form of money among four money stock measures adopted by RBI. As we proceed from M1 to M4, the liquidity gets reduced.
  • In other words, M4 possesses the lowest liquidity among all these measures. All these four money stack measures are not of equal importance. Their relative importance varies from the point of view of monetary policy.
  • Generally, in developed countries, the bank deposits are the most important component in money supply, while due to less banking habits in underdeveloped countries people want to keep their money in the most liquid form, i.e., currency.
  • M3 is the most important component among all money stock measures which is generally termed as ‘Broad Money’.

Cheap Money Policy and Dear Money Policy:

  • Cheap Money Policy is that Monetary Policy in which loans and advances are made available on low interest rate and easy terms to Industries, Businessmen and Consumers.
  • Cheap Money Policy increases the inflation rate in the economy and it is generally adopted to get rid of deflationary tendencies in the Economy.
  • On the other hand, dear money policy is adopted to squeeze the credit utilization facilities in the economy. Under dear Money Policy, interest rate is increased which helps in Controlling Inflation in the Economy.
The document Monetary System - Economics, UPSC, IAS. Notes | Study Indian Economy (Prelims) by Shahid Ali - UPSC is a part of the UPSC Course Indian Economy (Prelims) by Shahid Ali.
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