Summary

Barter system — direct exchange of goods for goods. Requires double coincidence of wants, limits trade. Money eliminates this problem by acting as a medium of exchange.

Functions of money: this chapter presents three — medium of exchange, unit of account (measure of value), and store of value. These make money a universally accepted facilitator of transactions.

Demand for money has two motives: transactions demand (for daily purchases, varies directly with income) and speculative demand (to hold cash instead of bonds when interest rates are expected to rise, varies inversely with the interest rate $r$).

Supply of money ($M$) is the total stock of currency and deposits held by the public. Measured as $M_1$ (currency + demand deposits) and $M_3$ ($M_1$ + time deposits). The central bank controls this supply.

Central bank (RBI) is the apex monetary authority. Its key functions: issuing currency, banker to the government and banks, lender of last resort, controller of credit, and managing foreign exchange.

Money creation by commercial banks — banks keep only a fraction of deposits as reserves (required reserve ratio $rr$). The rest is lent out, which creates new deposits. The money multiplier is $m = \frac{1}{rr}$. A deposit of ₹100 with $rr = 0.2$ can generate total deposits of ₹500.

Monetary policy tools used by the central bank to control money supply:

• Bank rate (rate at which RBI lends to banks) — raising it reduces money supply.
• Open market operations (buying/selling government securities) — buying injects money, selling absorbs it.
• Cash reserve ratio (CRR) — raising it reduces lending capacity.
• Statutory liquidity ratio (SLR) — raising it reduces funds available for loans.
• Repo rate (short-term borrowing rate for banks) — increasing it tightens liquidity.
• Reverse repo rate (rate RBI pays on banks' deposits) — increasing it encourages banks to park funds with RBI, reducing money supply. …