post reading economics

7/21/2019 Post Reading Economics

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Monetary system of anynation basically talks about

money, financial system ofthat nation and Central

banking.


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In economic literature money is defined asanything that is commonly accepted as a mediumof exchange.

Money performs four functions in all. Theyinclude:

1) Medium of exchange) Measure of value!) "tore of value

#) "tandard of deferred payments

Money and its functions


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Money is distinguished from near money on the groundsof li$uidity.

%i$uidity is defined as the ability of any asset to get itselfconverted into cash without the loss of time and value.

In India &'I offers various definitions of money on thebasis of li$uidity.

Money in India includes: (oins and (urrency

eposit money

Money * +ear money and %i$uidity


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(oins are money in metal form. They arereferred to as token money. The intrinsic valueof these coins is less than their face value.

(urrency notes in India are paper notes and donot carry intrinsic value .

In India paper currency takes the form of &s.,-,1 , ,- ,1 ,- , and 1, . The sole issue

authority is the &'I. It has the right to issue thecurrency notes mentioned above under the &'I

/ct, 10!#.

(urrency in India


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/long with coins and currencies demand depositsare also treated at par with money.

eposits accepted by banks are eitherwithdrawable on demand called demanddeposits) or are payable on maturity called timedeposits).

In India, &'I being the sole monetary authoritypublishes data relating to money. These are

referred to as money supply measures.

(urrency in India


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Money stock measures defined by the &'I are: M

1

, M ,M ! , M # M 1 2 (3 34 (M 1 is also known as narrow money)

5here,

( 2 (urrency held by the public 2 emand deposits of banks

4 2 4ther deposits of the &'I

M 2 M1

3 "avings deposits with post office savingsbanks M ! 2 M 1 3 +et time deposits of banks

(M! is also referred to as broad money)

M4 = M ! + Total deposits with the post office

&'I6s Measures of money supply


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evel of M 1 and M ! in Indian economy

Moneystock

measure

&upees in (rore) /mountoutstanding as on March !1, 7

M 1 0,8-,10-

M ! !!,1 , 79


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Financial System of India

Financial system of India contains Financial markets Financial institutions and

Financial instruments

Financial market include the money andthe capital market with former dealing inshort term borrowing and lending whilethe latter dealing in long term borrowingand lending


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inancial institutions in India have beenclassified as/) 'anking and ') +on 'anking

Institutions / very broad classification of banks is scheduledand non scheduled. This is on the basis of theamount of their deposit holdings.

/nother classification which is called thefunctional classification involves commercial andcooperative banks.

inancial institutions in India


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(ommercial 'anks in include both those ownedby the government and those privately owned. The govt. banks are known as the ;ublic sector

banks. They are 7 in number. The privately owned banks are classified as /)

Indian banks and ') oreign banks (ooperative banks operate at both the urban and

rural level. Those operating at the urban levelare commercial by function while those operatingin the rural areas work with social ob


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+on banking institutions of the other hand include:a) evelopment inancial Institutions Is)

b) "pecialised inancial Institutions " Is)

c) +on banking inance (ompanies +' (s) I cater to the development of different sectors of

the economy such as agriculture, industry etc.

" I are specialised investment institutions in areaslike insurance and investment. +' (s are finance companies other those

mentioned above.

+on 'anking finance companies in India


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inancial institutions are instrumental in purchaseand sale of financial instruments originating eitherthrough Money or (apital market.

Money market deals in short term funds. (apital market deals in long term funds.

The sub markets of the money market are:1) Inter*bank call money market

) 'ill market: a) Treasury bill marketb) (ommercial bill market

inancial Markets in India


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!) (ommercial ;aper market (;s)

#) (ertificate of eposits market ( s)

-) &epo market

8) Money Market Mutual und

The most popular sub market of the capital market is:The securities market both for private corporate and

government securities. These markets are well linked with the network of

financial institutions for the sale of financial instrumentsthese markets deal in to make a complete financialsystem.

inancial Markets in India


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The financial instruments the money market dealsin include:

1) Inter bank loans

) (ommercial paper!) 'ill of exchange

#) Treasury 'ills

-) (ommercial ;aper8) (ertificate of eposits etc.

inancial Instruments in Indian Money market


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The financial instruments of the capital marketinclude:1) "hares mainly =$uity and ;reference)

) ebentures (onvertible: ully and ;artly and+on convertible debentures)

!) 'onds 'oth corporate and >overnment)

"hare market is the most popular market forboth the domestic and international players.

The indicator showing progress and performance

of the stock market is known as the "=+"=?

inancial Instruments in Indian (apital market


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"ome &egulators of the inancial "ystem

Title &egulatorThe entire financialsystem

The &eserve 'ank ofIndia

The (apital Market "ecurities and =xchange'oard of India

Insurance Insurance &egulatoryand evelopment/uthority


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"ome /cts concerning the inancial"ystem of India

Transaction /ct'anking The 'anking &egulation /ct,

10#0

'anking The &eserve 'ank of India /ct,10!1

'anking The +egotiable Instruments /ct,1991

'anking eposit Insurance and (redit>uarantee (orporation /ct, 1081


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Some !cts concerning the "inancialSystem of India

Transaction /ct'anking The 'ankers6 books evidence act,

1901

'anking The oreign exchangeManagement /ct,

'anking The Transfer of ;roperty /ct,199

'anking The (ontract /ct, 197

'anking "ecuritisation /ct,


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Transaction /ct

"ecurities trading "ecurities (ontract

&egulation) /ct, 10-8"ecurities trading Income Tax /ct, 1081

"ecurities trading The (ompanies /ct, 10-8

"ecurities trading "='I /ct, 100


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Transaction /ct

oreign exchange The oreign exchange

Management /ct, oreign exchange The (onservation 4f oreign

=xchange /nd ;revention 4f

"muggling /ctivities /ct, 107#


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The entire banking industry in India isgoverned and is regulated by the &eserve 'ankof India which is the apex financial institutionof India.

Money gets velocity in the economy throughthe network of financial institutions. Thesefinancial institutions create credit.

(reation of excessive credit over the re$uiredlevel creates inflationary pressures in theeconomy via demand effect. isherian=$uation M@2;T proves it)

#overnance and working of the Monetary economy


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The &'I as the controller of credit controls thecredit creating capacity of these banks with thefollowing ob


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The monetary policy tools are:1) Bualitative tools

) Buantitative tools

The Buantitative tools aim at controlling the $uantum ofcredit in the economy while the $ualitative tools aim atchanging the direction of credit in the economy.

The Buantitative instruments include:1) @ariations in (ash &eserve &atio

) @ariations in the 'ank rate

!) 4pen Market 4perations

Monetary olicy tools in India


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The $ualitative instruments on the otherhand include:

1) Margin &e$uirements) Moral "uasion

!) irect /ction AAAA..etc

The &eserve 'ank of India was establishedas a private sector bank in 10!- under the&'I /ct, 10!#. it was brought under the

government control in 10#0.

Buantitative tools of Monetary control


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The &eserve 'ank performs all those ma


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4rganisation of the &'I is vested in the hands ofthe (entral 'oard of irectors composed undersection 9 of the &'I /ct, 10!#.

It consists of a >overnor and not more than #deputy governors and 1- other directors. Theyare appointed and nominated respectively by thecentral government.

or its functional flexibility and smoothness the&'I has established # of its local offices in India.These local offices are in Mumbai 5estern),

elhi +orth), (alcutta =ast) and Madras

"outh).

$rganisation of the &eserve 'ank


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The basic function performed by the &'I is that of noteissue. This currency is brought in circulation throughthe network of banking institutions.

'anks create credit. It means the banks use the depositscollected by them for lending.

In India we have fractional reserve banking system. 'yfractional reserve banking system we mean a certainportion of the deposits received by banks is needed to bemaintained statutorily) in cash with the central bank.

(urrency issue by the &'I and (redit (reation by banks


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This statutory cash holding with the centralbank by the banking system is called the (ash&eserve &atio.

(ash reserve in India ranges between aminimum of !C and a maximum of 1-C.

"o when a bank receives &s 1 D* from acustomer, the deposit holding of that bankgoes up by that amount.

If the cash reserve ratio is 1 C, the bank willbe able lend &s 0 .

rocess of multi*le credit creation


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&s 1 D* initial deposit on which that bank wouldmaintain a (&& of 1 C 1 x .1 2 1 D*) andthe remaining amount i.e. 1 E 1 2 0 ) &s 0 D*would be lent.

The 'alance sheet of ?FG bank would look like:

%iabilities &s /ssets &s

eposit 1 (ash reserves 1%oans 0

1 1



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%ending by one bank is transformed into deposits ofsome other banks. "uch deposits created out of loansare called the secondary deposits or the derived deposits.

The additional deposits created in another bank are usedby that bank for further lending after maintaining thenecessary cash reserves.

Initial deposit leads to creation of loan and that loan isfurther transformed into deposit. This is called theprocess of multiple credit creation. Multiple because thesame amount is being used several number of times forlending.

5hen a bank makes a loan from out of its deposits, themoney supply increases.



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rocess of Multi*le Credit Creation

!ash "eser#es

$ %%

&oans ' %%

eposits $% %%

&iabilities *ssets*,!- ,ank &td

$% %% $% %%

&iabilities *ssets./0- ,ank &td

eposits

%%

%% %%

!ash "eser#es

%

&oans $%

Money Supply = 190.00


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This process goes on until the initial depositis completely exhausted. /ccording to the money multiplier model

the process of money multiplication isexplained by the formula:

k 2 1Dr) x 1where, k is the multiplier and r is the cashreserve maintained by banks with thecentral bank.



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Hsing the multiplier formula in the previousexample of &s 1 D* with 1 C (&&) we get k

k 2 1D1 ) x 1k 2 1

If the multiplier is 1 , it means the initial depositin the economy would multiply 1 times.

In our example our initial deposit is &s1 D*.



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Total money multiplied would be an amounte$ual to: ) Initial deposit I ) x k Total money multiplied 2 I x k

In our exampleI 2 &s 1 D*

Money multiplier k) 2 1

/nd hence to the money multiplied in theeconomy would be e$ual to

2 1 x 1

2 1



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Hsing the same example we can find that if the&'I makes variations in the (&&, the moneysupply changes accordingly.

If the (&& is reduced to -C k moves up to obviously increasing the money supply) but

when (&& is increased to 1 C from -C, k isreduced to 1 . so this establishes an inverse

relation between (&& and money multiplier. ence the &'I uses (&& as the tool to control

money supply.

This is also known as the monetary policy tool.

+se of C&& to control credit


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+ational income means the income generatedby all the factors of production involved in theprocess of production in any economy duringa year.

@arious attributes to national income include:1) >+; >ross +ational ;roduct) ) > ; >ross

omestic ;roduct) !) + ; +et omestic ;roduct)

#) ++; +et +ational ;roduct)

=ach of these above mentioned attributescould be expressed in terms of market prices and atfactor cost.

>+; and > ;


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The difference between >+; and > ; is the value of netexport of that nation.

"o if >+; is expressed as:>+; 2 (3I3>3 ?*M)

5here,( 2 (onsumption expenditure

I2 Investment expenditure

>2 >overnment expenditure?*M)2 difference between value of exports and imports.

> ; is expressed as

> ; 2 (3I3>

>+; and > ;


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or an economy that does not trade, its > ; ise$ual to >+;.

or developed nations since the differencebetween value of exports and imports is close to

Jero, > ; and >+; figures are the same andhence they refer to only > ; and not >+;.

'ut underdeveloped nations need to talk aboutboth > ; and >+; because they suffer from

large trade deficits i.e. negative value of ?*M).

>+; and > ;

d


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The net values of the domestic product andnational product can be arrived at by deductingthe annual depreciation from the gross values.

++; 2 >+; E epreciationMethods of measuring +ational Income

Theexpenditure

method

Theoutputmethod

TheIncomemethod

>+; and > ;

"r /ctivities


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In India national income

data is compiled by the(entral "tatistical4rganisation ("4).

The ("4 classifieseconomic activitiesunder different heads tomake it convenient tocompute national

income. The activities considered

for calculating nationalincome are:

r+o .

/ctivities

1 /griculture, forestry and fishing

Mining and $uarrying

! Manufacturing

# =lect. gas and water supply

- (onstruction

8 Trade, hotels and restaurants

7 Transport, storage andcommunication

9 inancing, insurance, real estateK business services

0(ommunity, social and personal

services

>+; and > ;

>ross omestic ;roduct of India at factor cost


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>ross omestic ;roduct of India at factor cost1000* base year) &s in crore)

Item 1* * ! !* # #* - -* 8

> ; at actorcost

1 197 8-! # -#0#19 9--0!! ! - 0!

C contributionby /griculturalsector to > ;

!. .98 .0! 19.9 19.!

C contributionbyManufacturingsector to > ;

1-. 1 1-. 7 1-. # 1-.99 1-.09

>+; and > ; trends in India


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4ver last few years the contribution of the agricultural

sector in per cent terms) to the > ; is falling while thatof the manufacturing sector is increasing. / developed nation is one where the contribution of the

primary sector is less while that of the manufacturing

sector is more. India predominantly is an agrarian economy and hence

contribution of the agricultural sector to the > ;though falling is substantial.

Indian economy is showing positive signs of developmentas the contribution of the manufacturing sector isincreasing.

>+; and > ; trends in India


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&eferences /nd 5eb links

Modern monetary theory by Lishore >. Lulkarni,Macmillan India %td. =dn. 1000)

;rinciples of =conomics by +. >regory Mankiw, Thomson"outh 5estern, =dition )

Macroeconomics by ornbusch, ischer and "tartJ, IrwinMc>raw* ill, international 7th =dition)

Macroeconomics: ;rivate Markets and ;ublic (hoice by=kelund and Tollison, /ddison 5esley -th =dition)

=conomics by oseph "tiglitJ and (arl 5alsh, +orton and

company, third edition)


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&eferences /nd 5eb links ;rinciples of =conomics for (/ professional examination*I

by ;rem 'hutani, Taxmann publishers, second edition) Indian =conomy: L.Misra and @.L.;uri, imalaya;ublishing ouse !rd revised edition)

/n introduction to +ational Income /nalysis: 5ilfred'eckerman, published, in arrangement with 5eidenfeld and+icolson, 01, (lapham igh "treet, %ondon by Hniversal'ook "tall, elhi !rd edition)

http://mospi.nic.in http://www.rbi.org.in

http://www.cmie.com/ http://www.iibf.org.in/
http://mospi.nic.in/http://mospi.nic.in/

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