1. Money
Course: BBA-2
Subject: BE 2
Unit:2

2. Money:
 Money was not used in the early history
 Exchange were very few as family's were self-sufficient
 Exchanges were done by BARTER
( i.e exchange of goods for another goods)
 But there were many difficulties with it.

3. Definition of Money
 “Anything which is widely accepted in payments for goods or in
discharge of other kinds of business obligations.”
Or
 Anything that is generally acceptable as a means of exchange and
that at the same time acts as a measure and a store of value.

4. Function of Money
Money serves as a :
 Medium of Exchange
 Unit of Account
 Deferred payments
 Store value

5. Supply of Money

6. Money Supply
 Definition of Money Supply:
It refers to the amount of money which is in circulation in an
economy at any given time.
 Money supply plays a crucial role in the determination of price level
and interest rates.
 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.

7. Concept
 It is the total stock of money held by the people ( household, firms
and institutions)
 It the total sum of money available to the public in the economy at a
point of time
 It includes money held by the public and in circulation but it does not
include money held by Central Bank or Commercial Bank as they
are money creating agencies.
 The separation of producers of money from the users of money is
important from the viewpoint of both Monetary theory and policy

8.  It composed of two elements
 Currency with the Public (High Powered Money)
 Currency notes in circulation issued by Reserve Bank
of India
 The number of rupee notes and coins in circulation
 Small coins in circulation
 Demand Deposits with Public (Secondary Money)
Deposit of the public with the banks – Bank Money
 Demand Deposits
 Time Deposits
Concept

9. Constituents of Money Supply
Money Supply
Traditional Approach
(Narrow Money)
Coins, currency,
Demand Deposits
Modern Approach
(Broad Money)
Money
Coins, Currency,
Demand Deposits
Near Money

10.  It includes those items which can be spent immediately or readily
accepted as a medium of Exchange.
 Money that be spent directly, such as cash and current accounts
in banks.
M1= C +D + OD
C= Currency with the Public
D = Demand Deposits with the public in the commercial and
co-operative banks
OD = Other deposits held by the public with RBI
 Time deposits are excluded from it as its not possible to draw a
cheque against them.
Traditional Approach (M1)

11.  Coins
 Currency with the Public (High Powered Money)
 Demand Deposits with Public (Secondary Money)
 Time Deposits with banks
 Financial assets – deposits non-banking financial
intermediaries
 Bills – Treasury and Exchange bills
 Bonds and equities
Modern view extends the phenomenon of money to the whole
spectrum of liquidity in the assets portfolio of individuals in
modern economy.
Modern Approach

12. Measurement
 Money Supply is classified into various measures
 On the basis of its functions is that effective predictions
can be made about the likely affects on the economy of
changes in different components of Money Supply.
 RBI has adopted 4 concepts of Money Supply

13. Measurement
M0 :
Currency in circulation and in bank vaults. Its called as the
monetary base- the base from which other forms of money are
created.
A measure of the money supply which combines any liquid or
cash assets held within a central bank and the amount of
physical currency circulating in the economy
M1 / Narrow Money
M1= C +D + OD
C= Currency with the Public
D = Demand Deposits with the public in the commercial and
co-operative banks
OD = Other deposits held by the public with RBI

14. Measurement
Money Supply M2
M2= M1 + Saving deposit with the post office saving banks
The small saving deposits are not as liquid as demand deposits
but are more liquid than the time deposits.
M3 / Broad Money
M3 = M1 + Time Deposits with the banks
Time deposits are nit as liquid however loans from the banks can
be obtained against them and they can also be withdrawn any
time by forgoing interest earned on them.

15. Measurement
Money Supply M4
M4 = M3 + Total post office deposits (TPOD)
TPOD = Includes saving and time deposits of the public with the
post offices

16. Monetary
Aggregates: New Series
 Under the Working group on Money supply(WGMS),
the RBI has revised monetary data since April 1992,
and since 1999, has started publishing the new
monetary aggregates, namely M0(monetary base),
NM1(narrow money), NM2 (intermediate monetary
aggregate) and NM3 (broad money) based on the
residency concept.
 The new series clearly distinguishes between
monetary aggregates and liquidity aggregates.

17. Monetary Aggregates: New Series
 NM1
= Currency with + Demand liabilities portion of savings deposits
with the banking system
 NM2
= NM1+ time liabilities portion of savings deposits with the banking
system+ certificates of deposits issued by banks + term deposits
of residents with a contractual; maturity upto and including one year
with the banking system (excluding CDS)
 NM3
= NM2+ Long-term deposits of residents + Call/Term funding from
financial institutions =
Nm2 + term deposits of residents with a contractual maturity of over
one year with the banking system+ Call/Term borrowings from non-
depository financial corporations by the banking system.

18. Monetary Aggregates: New Series
 NM1includes only non-interest bearing assets monetary liabilities of
the banking sector,
 NM3, on the other hand, is an all encompassing measure that
includes long-term deposits.
 NM2 is an intermediate monetary aggregate that stands in between
narrow money NM1 and Broad money NM3.
 M4 is abolished in the new series

19. Liquidity Indicators
 Along with the above monetary aggregates for the proper
assessment of the liquidity the RBI also complies and evaluates
three different liquidity indicators L1, L2 andL3.
 L1= NM3+All deposits with the post office savings banks
(excluding National Savings Certificate)
 L2= L1+ Term deposits with term lending institutions and
refinancing institutions (FIs) + Term borrowing by FIs +Certificate
of deposits issued by FIs
 L3= L2+ Public deposits of non-banking financial companies.

20. Determinants of Money Supply
 M= Cp + D
 The two important determinant of Money supply are
 Reserve Money or Amount of High Powered Money
 Size of Money Multiplier

21. High Powered Money - H
 It denotes currency and coins issued by the Government and
Reserve bank of India.
H= Cp +R
Cp = Currency held by the public
R= Cash reserve s of currency with the banks
 RBI and Government are producers of high- powered money and
Banks are producers of demand deposits.
 For producing demand deposits or credit, banks have to keep with
themselves cash reserves of currency.
 As cash reserves leads to multiple creation of DD and larger
expansion of money supply.

22. Factors Determining Money Supply
 Monetary Base
 Monetary Gold Stock
 Reserve assets- Govt securities, bond , foreign exchange
 Central bank outstanding
 Bank credit to the Government
 Bank credit to the Commercial or Private Sector
 Community Choice – (Cash / Cheque)
 Changes in Net Foreign Exchange Assets.
 Government currency liabilities to the public
 Velocity of Circulation of Money

23. Velocity of Circulation of Money
 To find out supply of money over a period of time, we have to
consider the velocity of circulation of money
“It is the average number of time money circulates from
one hand to another”
i.E
Ms = MV
Supply of money during a given period is the total amount of money
circulation multiplied by the average number of times it has changed
hands during that period

24. Factors Affecting
Velocity of Circulation
 Time unit of Income receipts (per day/ per week/ per month)
 Method and habit of payment
 Degree of regularity of Income receipt
 Distribution of national Income
 Business Conditions
 Development of the Banking sector
 Speed in transportation of Money
 Liquidity preference Function

25. Demand of Money

26. Demand of Money
 Money is demanded because money serve some
purpose
 Medium of Exchange
 Store of Value

27. Distinct approach
Demand of Money
The Classical
Apporach
Keynesian Approach
Fisher Marshall/ Pigou
Transaction balance Cash Balance
Liquidity Preference

28. The Classical Approach
 Classical economist considered money as simply a means of
payment or medium of exchange.
 People are interested in the purchasing power of their money
holdings

29. Fisher Transactions Approach
 Money as a means of buying goods and services.
 Amount of money people have to hold to undertake a given volume
of transaction over a period of time
 Demand of money is determined by:
 The volume of Transaction
 Average price level per unit of transaction
 Velocity of circulation of money
MV= PT

30. Cambridge Cash Balance
Approach
 The approach stressed on money as store of value or wealth rather
than a medium of exchange.
 Demand for money is according to the choice- determined behaviour of the
people ( current interest rate, wealth owned by the individual, expectation of
future prices and future rate of interest)
 Individual demand for cash balance is proportional to the nominal income
Md = kPY
Y = Real national income
P= Average price level of currently produced goods
K = proportion of nominal income that people want to hold as cash
balances.

31. Keynes theory –
Liquidity Preference
 Liquidity preference means the demand for money to hold
Or
“desire of the public to hold cash”
 The desire for liquidity arises because of three motives
 Transaction motive
 Precautionary motive
 Speculative motive

32. a) Transaction Motive:
- Demand for money for the current transactions of individuals
and business firms.
- Individuals hold cash in order to bridge the interval
between the receipt of income and its expenditure.
b) Precautionary Motive:
- Desire for people to hold cash balances for unforeseen
contingencies (Unemployment, sickness, accidents….) .
- It depends upon the psychology of individual and the
conditions in which he lives.
“The money held in both the motives are mainly the function of
the size of Income.”
M1 = L1(y)
Y= Income
L1 = Demand Function
M1= Money demanded for Transaction and Precautionary motive

33. c) Speculative Demand for money
 Desire to hold ones resources in liquid form in order to take
advantage of the market movements regarding the future changes
in the rate of interest
 The cash is used to make speculative gains by dealing in bonds
whose prices fluctuate
 i.e Less money will be held under speculative motive at a higher
current rate of interest, More money will be held under this motive
at a lower current rate of interest.
 Thus demand for money under speculative motive is a function of rate of
interest
 M2 = L2 (r)
 r = rate of interest, L2 = demand function for speculative motive
 M2 = money demanded for speculative motive

34. Liquidity Trap
 The demand for money is a decreasing function of the rate of interest
 Higher the rate of interest lower the demand for money for speculative
motive and less money would be kept as inactive balance and vice versa.
 The LP curve becomes
perfectly elastic at
very low rate of interest
Speculative Demand
Rate
Of
interest
LP
Liquidity Trap

35. Liquidity Trap
 i.e it indicates a absolute liquidity prefrences of the people.
 At low rate of interest people will hold money as inactive balance which is
called as a liquidity trap.
 The expansion of money supply gets trapped and cannot effect rate of
interest and the level of investment.
 However demand of money does not depend so much upon the current
rate of interest as on expectations about changes in the rate on interest

36. Aggregate Demand for Money
 Md = M1 + M2
 Md = L1 (Y) + L2 (r )
Active Balance Idle Balance
Total Demand of Money
L2
L1 (Y1) L12(Y2) L3 (Y3)
L (Y1) L (Y3)I
n
t
e
r
e
s
t
R
a
t
e

37. INFLATION

38. What Is Inflation?
 Inflation is an increase in the average level of
prices for goods and services.
 It is an index, which shows how prices of
goods and services that is representative of
the economy as a whole are growing.

39. How is Inflation caused?
Inflation is caused by a combination of four factors:
 The supply of money goes up.
 The supply of other goods goes down.
 Demand for money goes down.
 Demand for other goods goes up.

40. How inflation is calculated?
 Whole sale Price Index (WPI)
 Consumer Price Index (CPI)

41. WPI
 Wholesale Price Index measures the average of the
changes of
goods and services price on the basis of wholesale
price.
 Presently 435 commodities price level is being tracked.
 The price index which is available on a weekly basis with
the shortest possible time lag of only two weeks.
 India considers 1993-94 financial year as base year for
present WPI index calculation.

42. WPI
 Each commodity has some weightage in the WPI
index.
1. Primary Articles (weightage: 22.02525%)
2. Fuel, Power, Light & Lubricants
(weightage: 14.22624%)
3. Manufactured Products
(weightage: 63.74851%)

43. CPI
 It is a price index that tracks the prices of a specified
basket of consumer goods and services, providing a
measure of inflation.
 CPI is a fixed quantity price index and considered by
some a cost of living index.
 CPI is used by the government, private sector,
embassies, etc to compute the dearness
allowance (DA )

44. CPI
Why is India not switching over to the CPI?
 There are four different types of CPI indices, and that
makes switching over to the Index from WPI fairly
'risky and unwieldy.
CPI Industrial Workers
CPI Urban Non-Manual Employees
CPI Agricultural labourers
CPI Rural labour.
 CPI cannot be used in India because there is too much
of a lag in reporting CPI numbers

45. Types Of Inflation
 Demand – Pull Inflation
 Cost- Push Inflation

46. Demand –Pull Inflation
The inflation resulting from an increase in aggregate demand at full
employment level which exceeds the supply of goods at current prices.
The reason for increase in demand are:
 Increases in the money supply
Supply of money goes up, rate of interest falls, Investment will
increase, Increase income of factors of production, consumption
expenditure will increase, leads to increase in demand.
 Increases in Government purchases
Demand for other goods go up.
 Increases in the price level in the rest of the world
 Increase in marginal propensity to consume

47. Demand –Pull Inflation
AD1
AD2
Price Level
P
P1
AS
AD
Aggregate Demand and Supply
Y
P2

48. Cost –Push Inflation
 Inflation can result due to decrease in aggregate supply
 Aggregate supply is the total value of the goods and services
produced in a country, plus the value of imported goods less the value of
exports.
 The reason for decrease in supply are
 Wage – Push Inflation: An increase in wage rates
 Profit- Push Inflation
 An increase in the prices of raw materials
These sources of a decrease in aggregate supply operate by increasing
costs, and the resulting inflation is called cost-push inflation

49. Cost –Push Inflation
AS
AD
Output
Y
Price Level
P
P1
AS1
Y1

50. Deflation
 In economics, deflation is a decrease in the general price
level of goods and services.
 Deflation occurs when the inflation rate falls below zero percent,
resulting in an increase in the real value of money – a negative
inflation rate.
 This should not be confused with disinflation, a slow-down in the
inflation rate (i.e. when the inflation decreases, but still remains
positive).
 Inflation reduces the real value of money over time, conversely,
deflation increases the real value of money. Money refers to the
functional currency (mostly unstable monetary unit of account) in a
national or regional economy.

51.  Currently, mainstream economists generally believe that deflation is
a problem in a modern economy
 Deflation is correlated with recessions including the Great
Depression, as banks defaulted on depositors. Additionally,
deflation may cause the economy to enter the liquidity trap.

52. Hyperinflation
 In economics, hyperinflation is inflation that is very high or "out
of control", a condition in which prices increase rapidly as a
currency loses its value.
 Many of the worst periods of hyperinflation are preceded by
deflation.
 With high levels of government debt, severe cases of deflation
cause a loss of confidence in the nation's currency by shrinking
the economy and making the government's debt appear
increasingly unsustainable. The loss of confidence then causes
the flow of money to speed up as individuals become desperate
to exchange cash for real goods as fast as possible, producing
hyperinflation.

53. Stagflation
• A condition of slow economic growth and relatively
high unemployment - a time of stagnation -
accompanied by a rise in prices, or inflation.
• Stagflation occurs when the economy isn't growing
but prices are, which is not a good situation for a
country to be in.
• This happened to a great extent during the 1970s,
when world oil prices rose dramatically, fuelling
sharp inflation in developed countries.

54. Source
 Macroeconomics: Theory and Policy-Vanita Agarwal, Pearson Publication
 Macro Economics-D.M. Mithani, Himalaya Publishing House, Mumbai
 Macro Economics-H.L.Ahuja, S. Chand and Company Ltd., Delhi
 Macro Economic theory-M.C.Vaish, Vikas Publishing House, Delhi
 Macro Economic Analysis-Edward Shapiro, Galyotia Publications (P) Ltd
 Macro Economics-M.L. Seth, Lakshmi Narayan Agarwal Publishers