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Monetary System
Money
What is money?
- Which act as a unit of value
- Which act as a medium of exchange
- 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
- Full Bodied Money
- 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.
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FAQs on Monetary System - Economics, UPSC, IAS. - Indian Economy (Prelims) by Shahid Ali
| 1. What is the monetary system? |  |
Ans. The monetary system refers to the set of rules, institutions, and procedures that govern the creation, distribution, and management of money within an economy. It includes the central bank, commercial banks, financial markets, and various monetary policies implemented to control inflation, stabilize the economy, and promote economic growth.
| 2. What is the role of the central bank in the monetary system? | |
Ans. The central bank plays a crucial role in the monetary system. It is responsible for issuing and controlling the supply of money, regulating interest rates, supervising commercial banks, and managing foreign exchange reserves. The central bank's primary objective is to maintain price stability and ensure the smooth functioning of the financial system.
| 3. How does the monetary system affect the economy? | |
Ans. The monetary system has a significant impact on the economy. Changes in the money supply and interest rates influence borrowing costs, investment decisions, and consumer spending. Monetary policies, such as lowering interest rates, can stimulate economic growth, while tightening policies can curb inflation. The stability and efficiency of the monetary system are crucial for promoting economic stability and development.
| 4. What are the advantages of a well-functioning monetary system? | |
Ans. A well-functioning monetary system brings several advantages to an economy. It provides a stable medium of exchange, facilitating transactions and trade. It promotes price stability, ensuring that inflation remains under control, which helps maintain the purchasing power of money. A robust monetary system also enhances financial stability, encourages investment, and supports economic growth.
| 5. How does the monetary system impact individuals and businesses? | |
Ans. The monetary system directly affects individuals and businesses in various ways. Changes in interest rates can impact borrowing costs, affecting individuals' ability to access credit for purchasing homes, cars, or starting businesses. Inflation erodes the value of money over time, reducing individuals' purchasing power. Businesses rely on the monetary system to make investment decisions, manage cash flows, and plan for the future. A stable and predictable monetary system is vital for individuals and businesses to make informed financial choices.
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