# Money Market – CA Inter Economics Study Material

Money Market – CA Inter Economics Study Material is designed strictly as per the latest syllabus and exam pattern.

## Money Market – CA Inter Economics Study Material

Theory Questions

Question 1.
What would be the impact of each of the following on credit multiplier and money supply? (3 Marks May 2018)
(a) If Commercial Banks keep 100 percent reserves.
(b) If Commercial Banks do not keep reserves.
(c) If Commercial Banks keep excess reserves.
Credit Multiplier = 1 ÷ required reserve ratio
(a) If commercial banks keep 100% reserves, the reserve deposit ratio is one and the value of money multiplier is one. Deposits simply substitute for the currency that is held by banks as reserves and therefore, no new money is created by banks.

(b) If commercial banks do not keep reserves and lends the entire deposits, it is a case of zero required reserve ratio and credit multiplier will be infinite and therefore money creation will also be infinite.

(c) Excess reserves are reserves over and above what banks are legally required to hold against deposits. The additional units of money that goes into ‘excess reserves’ of the commercial banks do not lead to any additional loans, and therefore, these excess reserves do not lead to creation of money. The increase in banks’ excess reserves reduces the credit multiplier, causing the money supply to decline.

Question 2.
Explain the following modified equation of exchange as given by Irving Fisher: MV+M’ V’ = PT. (3 Marks May 2018)
Modified Equation of exchange as given by Irving Fisher: MV + M’V’ = PT

This is an extended form of the original equation of exchange which Fisher gave to include demand deposits (M’) and their velocity (V’) in the total supply of money. The equation can also be rewritten as P = (MV + M’ V’) / T.

From the above equation, it is evident that the price level is determined by the following factors:
(a) Quantity of money in circulation (M),
(b) The velocity of circulation of money (V), .
(c) The volume of credit money (M’), the velocity of circulation of credit money (V’) and the volume of trade (T).

The equation of exchange further shows that the price level (P) is directly related to M, V, M’ and V’. It is, however, inversely related to T. Velocity of money in circulation (V) and the velocity of credit money (V’) remain constant. Since full employment prevails and since T is function of national income the volume of transactions T is fixed in the short run.

The total volume of transactions (T) multiplied by the price level (P) represents the demand for money. The demand for money (PT) is equal to the supply of money (MV + M’V’). In any given period, the total value of transactions made is equal to PT and the value of money flow is equal to MV+ M’V’.

Question 3.
Explain why people hold money according to Liquidity Preference Theory. (3 Marks May 2018)
People hold money according to Liquidity Preference Theory for following three motives:
1. The transactions motive: People hold cash for current transactions for personal and business exchanges i.e. to bridge the time gap between receipt of income and planned expenditures.

2. The precautionary motive: People hold cash to make unanticipated expenditures that may occur due to unforeseen and unpredictable contingencies.

3. The speculative motive:This motive reflects people’s desire to hold cash in order to be equipped to exploit any attractive investment opportunity requiring cash expenditure. According to Keynes, people demand to hold money balances to take advantage of the future changes in the rate of interest, which is the same as future changes in bond prices.

Question 4.
Explain the difference between Liquidity Adjustment Facility (LAP) and Marginal Standing Facility (MSF). (3 Marks May 2018}
Liquidity Adjustment Facility (LAF): Liquidity Adjustment Facility (LAF) which was introduced by RBI in June, 2000, is a facility extended to the scheduled commercial banks and primary dealers to avail of liquidity in case of requirement on an overnight basis against the collateral of government securities including state government securities. Its objective is to assist banks to adjust their day to day mismatches in liquidity. Currently, the RBI provides financial accommodation to the commercial banks through repos/reverse repos under LAF.

Marginal Standing Facility (MSF): Marginal Standing Facility (MSF) which was introduced by RBI in its monetary policy statements 2011-12, refers to the facility under which scheduled commercial banks can borrow additional amount of overnight money from the central bank over and above what is available to them through the LAF window by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest.

This provides a safety valve against unexpected liquidity shocks to the banking system. The MSF would be the last resort for banks once they exhaust all borrowing options including the liquidity adjustment facility.

Question 5.
How do changes in Cash Reserve Ratio (CRR) impact the economy? (2 Marks May 2018)
Impact of changes in Cash Reserve Ratio (CRR): Change in Cash Reserve Ratio is one of the important quantitative tools aiding in liquidity management. Higher the CRR with the central bank, lower will be the liquidity in the system and vice versa. In order to control credit expansion during periods of inflation, the central bank increases the CRR. With higher CRR, banks have to keep more reserves and the banks’ lendable resources get depleted leading to decrease in the volume of bank lending and contraction in credit and money supply in the economy.

During deflation, the central bank reduces the CRR in order to enable the banks to expand credit and increase the supply of money available in the economy. With more credit available in the market, economic activities get accelerated bringing the economy back to stability and economic growth.

Question 6.
Explain the role of Monetary Policy Committee (MPC) in India. (3 Marks Nov 2018)
Role of Monetary Policy Committee (MPC) in India: Monetary Policy Committee (MPC) constituted by the Central Government is an empowered six-member committee with RBI Governor as the chairperson. Under the Monetary Policy Framework Agreement, the RBI will be responsible for price stability and for containing inflation targets at 4% (with a standard deviation of 2%) in the medium term.

The committee is answerable to the Government of India if the inflation exceeds the range prescribed for three consecutive months. MPC has complete control over monetary policy decisions to ensure economic growth and price stability. The MPC decides the changes to be made to the policy rate (repo rate) so as to contain inflation within the target level specified to it by the Central Government.

Fixing of the benchmark policy interest rate (repo rate) is made in a more consultative and participative manner and on the basis of majority vote by this panel of experts. This has added lot of value and transparency to monetary policy decisions.

Question 7.
Mention the general characteristics of Money. (2 Marks Nov 2018)
Characteristics of money are:

1. Generally acceptable,
2. Durable or long-lasting,
3. Effortlessly recognizable, ‘
4. Difficult to counterfeit i.e. not easily reproducible by people,
5. Relatively scarce, but has elasticity of supply,
6. Portable or easily transported,
7. Possessing uniformity; and
8. Divisible into smaller parts in usable quantities or fractions without losing value.

Question 8.
Explain the different mechanism of monetary policy which influences the price level and national income. (3 Marks Nov 2018)
Different mechanisms of monetary policy or monetary transmission mechanism are:
(1) The interest rate channel A contractionary monetary policy-induced increase in interest rates increases the cost of capital and the real cost of borrowing for firms and households with the result that they cut back on their investment expenditures and durable goods consumption expenditures respectively.

A decline in aggregate demand results in a fall in aggregate output and employment. Conversely, an expansionary monetary policy induced decrease in interest rates will have the opposite effect through decreases in cost of capital for firms and cost of borrowing for households.

(2) The exchange rate channel The exchange rate channel works through expenditure switching between domestic and foreign goods. Appreciation of the domestic currency makes domestically produced goods more expensive compared to foreign-produced goods. This causes net exports to fall; correspondingly domestic output and employment also fall.

(3) The quantum channel (e.g., relating to money supply and credit) Two distinct credit channels: the bank lending channel and the balance sheet channel- also allow the effects of monetary policy actions to propagate through the real economy. Credit channel operates by altering access of firms and households to bank credit.

A direct effect of monetary policy on the firm’s balance sheet comes about when an increase in interest rates works to increase the payments that the firm must make to service its floating rate debts. An indirect effect sets in, when the same increase in interest rates works to reduce the capitalized value of the firm’s long-lived assets.

(4) The asset price channel: Asset prices respond to monetary policy changes and consequently impact output, employment and inflation. A policy-induced increase in the short-term nominal interest rates makes debt instruments more attractive than equities in the eyes of investors leading to a fall in equity prices, erosion in household financial wealth, fall in consumption, output, and employment.

Question 9.
Explain the Monetary Policy Framework Agreement. (2 Marks Nov 2018)
The Reserve Bank of India (RBI) Act, 1934 was amended in 2016, for giving a statutory backing to the Monetary Policy Framework Agreement. It is an agreement reached between the Government of India and the RBI on the maximum tolerable inflation rate that the RBI should target to achieve price stability.

The amended RBI Act (2016) provides for a statutory basis for the implementation of the ‘flexible inflation targeting framework’ by abandoning the ‘multiple indicator’ approach. The inflation target is to be set by the Government of India, in consultation with the Reserve Bank, once in every five years. Accordingly:

1. The Central Government has notified 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5,2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
2. The RBI is mandated to publish a Monetary Policy Report every six months, explaining the sources of inflation and the forecasts of inflation for the coming period of six to eighteen months.

Question 10.
Why is the central bank referred to as a “banker’s bank”? (2 Marks May 2019)
A central bank referred to as a ‘banker’s bank’ because:
(1) The central bank acts as a custodian of cash reserves of commercial banks in the country.

(2) The central bank provides efficient means of funds transfer for all banks. All commercial banks maintain accounts with the central bank and it enables smooth and swift clearing and settlements of inter-bank transactions and interbank payments.

(3) The central bank acts as a lender of last resort. It provides liquidity to banks when the latter face shortage of liquidity. The scheduled commercial banks can borrow from the discount window against the collateral of securities like commercial bills, government securities, treasury bills, or other eligible papers.

Question 11.
“Money has four functions: a medium, a measure, a standard and a store.” Elucidate. (2 Marks May 2019, 3 Marks Nov 2020)
Four functions of money are:
1. Money is a convenient medium of exchange: Money is a convenient me
dium of exchange or it is an instrument that facilitates easy exchange of goods and services. Money, though not having any inherent power to directly satisfy human wants, by acting as a medium of exchange, it commands purchasing power and its possession enables us to purchase goods and services to satisfy our wants. By acting as an intermediary, money increases the ease of trade and reduces the inefficiency and transaction costs involved in a barter exchange.

By decomposing the single barter transaction into two separate transactions of sale and purchase, money eliminates the need for double coincidence of wants. Money also facilitates separation of transactions both in time and place and this in turn enables us to economize on time and efforts involved in transactions.

2. Money is a ‘common measure of value: The monetary unit is the unit of measurement in terms of which the value of all goods and services is measured and expressed. It is convenient to trade all commodities in exchange for a single commodity.

So also, it is convenient to measure the prices of all commodities in terms of a single unit, rather than record the relative price of every good in terms of every other good. A common unit of account facilitates a system of orderly pricing which is crucial for rational economic choices. Goods and services which are otherwise not comparable are made comparable through expressing the worth of each in terms of money.

3. Money serves as a unit or standard of deferred payment: Money facilitates recording of deferred promises to pay. Money is the unit in terms of which future payments are contracted or stated. However, variations in the purchasing power of money due to inflation or deflation, reduces the efficacy of money in this function.

4. Money is a store of value: People prefer to hold it as an asset, that is, as part of their stock of wealth. The splitting of purchases and sale into two transactions involves a separation in both time and space. This separation is possible because money can be used as a store of value or store of means of payment during the intervening time. Again, rather than spending one’s money at present, one can store it for use at some future time.

Thus, money functions as a temporary abode of purchasing power in order to efficiently perform its medium of exchange function. Money also functions as a permanent store of value. Money is the only asset which has perfect liquidity.

Question 12.
Describe the determinants of demand for money as identified by Milton Friedman in his restatement of Quantity Theory of demand for money. (3 Marks May 2019)
Determinants of demand of money as per Milton Friedman’s restatement of Quantity theory of demand of money are:

1. Permanent income and
2. Relative returns on assets (which incorporate risk).

Friedman maintains that it is permanent income and not current income as in the Keynesian theory that determines the demand for money. Permanent income which is Friedman’s measure of wealth is the present expected value of all future income. To Friedman, money is a good as any other durable consumption good and its demand is a function of a great number of factors. Friedman identified the following four determinants of the demand for money. The nominal demand for money:

(a) is a function of total wealth, which is represented by permanent income divided by the discount rate, defined as the average return on the five asset classes in the monetarist theory world, namely money, bonds, equity, physical capital and human capital.
(b) is positively related to the price level P. If the price level rises the demand for money increases and vice versa.
(c) rises, if the opportunity costs of money holdings (i.e. returns on bonds and stock) decline and vice versa.
(d) is influenced by inflation, a positive inflation rate reduces the real value of money balances, thereby increasing the opportunity costs of money holdings.

Question 13.
Explain the open market operations conducted by RBI. (2 Marks Nov 2019)
Open market operations conducted by RBI: Open Market Operations (0M0) is a general term used for monetary policy involving market operations conducted by the Reserve Bank of India by way of sale or purchase of government securities to/from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.

When the Reserve Bank of India feels that there is excess rupee liquidity in the market, it resorts to sale of government securities for absorption of the excess liquidity. Similarly, when the liquidity conditions are tight, the RBI will buy securities from the market, thereby injecting liquidity into the market.

Question 14.
Explain ‘Reverse Repo Rate’. (2 Marks Nov 2019)
Reverse Repo Rate: ‘Reverse repo operation’ is a monetary policy instrument and in effect it absorbs the liquidity from the system. This operation takes place when the RBI borrows money from commercial banks by selling them securities (which RBI permits) with an agreement to repurchase the securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed. The interest rate paid by the RBI for such borrowings is called the “Reverse Repo Rate”. Thus, reverse repo rate is the rate of interest paid by the RBI on its borrowings from commercial banks.

Question 15.
Explain the neo-classical approach to demand for money. (3 Marks Nov 2019)
Neo-Classical Approach: The Neo-classical Approach or the cash balance approach put forth by Cambridge economists holds that money increases utility in the following two ways:

1. for transaction motive, ie. for enabling the possibility of split-up of sale and purchase to two different points of time rather than being simultaneous,
2. as a temporary store of wealth ie. for a hedge against uncertainty.

Since demand for money also involves a precautionary motive in this approach and money gives utility in its store of wealth and precautionary modes, money is demanded for itself. How much money will be demanded depends:
(a) partly on income which points to transactions demand, such that higher the income, the greater the quantity of purchases and as a consequence greater will be the need for money as a temporary abode of value to overcome transactions costs, and

(b) partly on other factors of which important ones are wealth and interest rates.
The Cambridge equation is stated as:
Md = k PY
Where,
Md = is the demand for money
Y = real national income
P = average price level of currently produced goods and services
PY = nominal income
K = proportion of nominal income (PY) that people want to hold as cash balances
The term ‘k’ in the above equation is called ‘Cambridge k’. The equation above explains that the demand for money (M) equals k proportion of the total money income. The neo-classical theory changed the focus of the quantity theory of money to money demand and hypothesized that demand for money is a function of money income.

Question 16.
What is the impact of the following on credit multiplier and money supply, if Commercial Banks keep: (2 Marks Nov 2020)
(1) Less Reserve?
(2) Excess Reserve?
Credit Multiplier = 1 ÷ Required Reserve Ratio
(1) The impact on credit multiplier and money supply, if commercial banks keep less reserves: The Credit Multiplier describes the amount of additional money created by commercial banks through the process of lending the available money it has in excess of the central bank’s reserve requirements.

Thus the credit multiplier is inextricably tied to the bank’s reserve requirement. If reserve ratio is 40%, then credit multiplier = 1 ÷ 0.40 = 2.5. If banks need to keep only less reserve, then the credit multiplier would be high and therefore money supply would be higher. If the reserve ratio is only 20%, then the credit multiplier is 1 ÷ 0.20 = 5.

(2) The impact on credit multiplier and money supply, if commercial banks keep excess reserve: ‘Excess reserves’ refers to the positive difference between total reserves (TR) and required reserves (RR). The money that is kept as ‘excess reserves’ of the commercial banks do not lead to any additional loans, and therefore, these excess reserves do not lead to creation of credit. When banks keep excess reserves, the credit multiplier would be low and it impact on money supply would be less.

Question 17.
“The deposit multiplier and the money multiplier though closely related are not identical”. Explain briefly. (2 Marks Nov 2020)
The Deposit Multiplier and the Money Multiplier: The money multiplier denotes by ‘how much the money supply will change for a given change in high-powered money’. The deposit multiplier describes the amount of additional money created by commercial bank through the process of lending the available money it has in excess of the central bank’s reserve requirements. Though closely related they are not identical because:

(1) Generally banks do not lend out all of their available money, but instead maintain reserves at a level above the minimum required reserve. In other words, banks keep excess reserves.

(2) The public prefers to hold some cash and therefore, some of the increase in loans will not be deposited at the commercial banks, but will be kept cash. This means, that when new reserves enter the banking system they will not be multiplied entirely by the deposit multiplier into new demand deposits. Some money will leave the banking system in the form of cash. Therefore, the money supply will be raised by less than the demand deposits.

If some portion of the increase in high-powered money finds its way into currency, this portion does not undergo multiple deposit expansion. The size of the money multiplier is reduced when funds are held as cash rather than as demand deposits.

Question 18.
What is the meant by ‘Statutory Liquidity Ratio’? -In which forms this ratio is maintained? (3 Marks Nov 2020)
The Statutory Liquidity Ratio: The Statutory Liquidity Ratio (SLR) is the ratio of a bank’s liquid assets to its net demand and time liabilities (NDTL).

As per the Banking Regulations Act, 1949, all scheduled commercial banks in India are required to maintain a stipulated percentage of their total Demand and Time Liabilities (DTL) / Net DTL (NDTL) in one of the following forms:

1. Cash,
2. Gold, or
3. Investments in un-encumbered Instruments that include:
(a) Treasury-bills of the Government of India.
(b) Dated securities including those issued by the Government of India from time to time under the market borrowings programme and the Market Stabilization Scheme (MSS).
(c) State Development Loans (SDLs) issued by State Governments under their market borrowings programme.
(d) Other instruments as notified by the RBI. These include mainly the securities issued by PSEs.
The SLR requires holding of assets in one of the above three categories by the bank itself.

Question 19.
Explain the Transactions Motive for holding cash. (2 Marks Jan 2021)
Transactions Motive for holding cash:The transactions motive for holding cash relates to ‘the need for cash for current transactions for personal and business exchange.’ The need for holding money arises between as there is lack of synchronization between receipts and expenditures.

The transaction motive is further classified into income motive and business motive, both of which stressed on the requirement of individuals and businesses respectively to bridge the time gap between receipt of income and planned expenditure. The transaction demand for money is a direct proportional and positive function of the level of Income.
Lr = KY
Where,
Lr = is the transaction demand for money
K = is the ratio of earnings which is kept for transaction purposes
Y = is the earning

Question 20.
Distinguish between Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). (3 Marks Jan 2021)
Cash Reserve ratio (CRR): Cash Reserve Ratio (CRR) refers to the average daily balance that a bank is required to maintain with the Reserve bank of India as a share of its total net demand and time liabilities (NDTL). This Percentage will be notified from time to time by Reserve bank of India. The RBI may set the ratio in keeping with the broad objective of maintaining monetary stability in the economy.

This requirement applies uniformly to all the scheduled banks in the country irrespective of its size or financial position. Higher the CRR with the RBI, lower will be the liquidity in the system and vice versa. During Slowdown in the economy, the RBI reduces the CRR in order to enable the banks to expand credit and increase the supply of money available in the economy. In order to contain credit expansion during the period of high inflation, the RBI increases the CRR.

The Statutory Liquidity Ratio: The Statutory Liquidity Ratio (SLR) is the ratio of a bank’s liquid assets to its net demand and time liabilities (NDTL).

As per the Banking Regulations Act, 1949, all scheduled commercial banks in India are required to maintain a stipulated percentage of their total Demand and Time Liabilities (DTL)/Net DTL (NDTL) in one of the following forms:

1. Cash,
2. Gold, or
3. Investments in un-encumbered Instruments that include:
(a) Treasury-bills of the Government of India.
(b) Dated securities including those issued by the Government of India from time to time under the market borrowings programme and the Market Stabilization Scheme (MSS).
(c) State Development Loans (SDLs) issued by State Governments under their market borrowings programme.
(d) Other instruments as notified by the RBI. These include mainly the securities issued by PSEs.

While CRR has to be maintained by banks as cash with the RBI, the SLR requires holding of assets in one of the above three categories by the bank itself. The Banks which fail to meet its SLR obligations are liable to be imposed penalty in the form of penal interest payable to RBI. The SLR is also a powerful tool for controlling liquidity in the domestic market by means of manipulating bank credit.

Question 21.
Discuss the role of ‘Market Stabilization Scheme* In our economy. (2 Marks Jan 2021)
Market Stabilization Scfieme/Market Stabilization Scheme was introduced in 2004 as an Instrument for monetary management with the primary aim of aiding the sterilization operations of the RBI. (Sterilization is the process by which the monetary authority sterilizes the effects of significant foreign capital inflows on domestic liquidity by off- loading parts of the stock of government securities held by it).

Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short, dated government securities and treasury bills. Under this Scheme, the government of India borrows from the RBI (Such borrowing being additional to its normal borrowing requirements and issues treasury-bills/dated securities for absorbing excess liquidity from the market arising from large capital inflows.

Question 22.
Explain the concept of ‘Money Multiplier’. (2 Marks Jan 2021)
Money Multiplier (m) = Money Supply ÷ Monetary Base
Money Multiplier: Money multiplier (m) is defined as a ratio that relates the changes in the money supply to a given change in the monetary base. It is the ratio of the stock of money to the stock of high-powered money. It denotes by how much the money supply will change for a given change in high powered money. It denotes by how much the money supply will change for a given change in high powered money.

The money multiplier process explains how an increase in the monetary base causes, the money supply to increase by a multiplied amount. For example, if there is an injection of ₹ 500 Crores through an open market operation by the Central Bank of the country and if it leads to an increment of ₹ 5,000 Crores of final money supply, then the money multiplier is said to be 10. Hence the multiplier indicates the change in monetary base which is transformed into money supply.

Question 23.
What do you mean by ‘Reserve Money’? (2 Marks Jan 2021)
The Reserve Money, also known as central bank money, base money or high powered money determines the level of liquidity and the price level in the economy.
Reserve Money = Currency in Circulation + Banker’s deposits with the RBI + other deposits with the RBI.
= Net RBI credit to the government + RBI credit to the commercial sector + RBI’s claim on banks + RBI’s net foreign exchange assets + Government Currency liabilities to the Public- RBI’s net non-monetary liabilities

Practical Problems

Question 1.
The RBI published the following data as on 31st March, 2018. You are required to compute M4: (3 Marks Nov 2018)
(₹ in crores)
Currency with the public – 1,12,206.6
Demand Deposits with Banks – 1,93,300.4
Net Time Deposits with Banks – 2,67,310.2
Other Deposits of RBI – 614.8
Post Office Savings Deposits – 277.5
Post Office National Savings Certificates (NSCs) – 110.5
M4 = Currency and coins with the people + demand deposits with the banks (Current and Saving accounts) + other deposits with the RBI + Net time deposits with the banking system + Total deposits with the Post Office Savings (excluding National Savings Certificates)
= 1,12,206.6 +1,93,300.4 + 2,67,310.2 + 614.8 + 277.5 = 5,73,709.5 Crores

Question 2.
Compute Ml supply of money from the data given below: (3 Marks May 2019)
Currency with public – ₹ 2,13,2798 Crores
Time deposits with bank – ₹ 3,45,000.7 Crores
Demand deposits with bank – ₹ 162,74.5 Crores
Post office savings deposit – ₹ 382.9 Crores
Other deposits of – ₹ 765.1 Crores
M1 = Currency and coins with the people + demand deposits of banks (current and saving accounts) + other deposits of the RBI.
= ₹ 2,13,279.8 + ₹ 1,62,374.5 + ₹ 765.1
= ₹ 3,76,419.4 Crores

Question 3.
What will be the total credit created by the commercial banking system for an initial deposit of ₹ 3,000 at a Required Reserve Ratio (RRR) of 0.05 and 0.08 respectively? Also compute credit multiplier. (2 Marks May 2019)
Credit Multiplier = 1 ÷Required Reserve Ratio
For RRR 0.05 : Credit Multiplier = 1/0.05 = 20
For RRR0.08 : Credit Multiplier = 1/0.08 = 12.5
Credit Creation = Initial Deposit × Credit Multiplier
For RRR 0.05 : Credit creation = ₹ 3,000 × 20 = ₹ 60,000
For RRR 0.08 : Credit creation = ₹ 3,000 × 12.5 = ₹ 37,500

Question 4.
Compute reserve money from the following data published by RBI: (3 Marks Nov 2019)

 ₹ in crores Net RBI credit to the government 8,51,651 RBI Credit to the commercial sector 2,62,115 RBI’s claim on Banks 4,10,315 Government’s Currency liabilities to the public 1,85,060 RBI’s net foreign assets 72,133 RBI’s net non-monetary liabilities 68,032

Reserve Money = Net RBI credit to the Government + RBI credit to the Commercial sector + RBI’s Claims on banks + RBI’s net Foreign assets + Government’s Currency liabilities to the public – RBI’s net non – monetary Liabilities.
= 8,51,651 + 2,62,115 + 4,10,315 + 72,133 + 1,85,060 – 68,032
= 17,13,242 Crores

Question 5.
Compute credit multiplier if the required reserved ratio is 10% and 12.5% for every ₹ 1,00,000 deposited in the hanking system. What will be the total credit money created by the banking system in each case? (2 Marks Nov 2019)
(a) Credit Multiplier = $$\frac{1}{\text { Required Reserved Ratio }}$$
For RRR 10% : Credit Multiplier = 1 / 10% = 10
For RRR 12.5% : Credit Multiplier = 1/12.5% = 8

(b) Credit creation = Initial deposits × Credit Multiplier
For RRR 10% : Credit creation = 1,00,000 × 10 = 10, 00,000
For RRR 12.5% : Credit creation = 1,00,000 × 8 = 8, 00,000

Question 6.
Compute M3 from the following data: (3 Marks Nov 2020)

 Component ₹ in Crores Currency with the public 2,23,432.6 Demand Deposits with Banks 3,40,242.4 Time Deposits with Banks 2,80,736.8 Post office savings Deposits                                                 ‘ 446.7 (Excluding National Saving Certificates) Other Deposits with RBI 392.7 (Including Government Deposits) Post Office National Saving Certificates 83.7 Government Deposits with RBI- 102.5

M3 = Currency with the public + Demand deposits with the banks 4- Time deposits with the banks + ‘Other’ deposits with the RBI
= 2,25,432.6 + 3,40,242.4 + 2,80,736.8 + (392.7 – 102.5)
= ₹ 8,46,702 Crores

Question 7.
Compute M2 supply of money from the following RBI data: (3 Marks Jan 2021)

 Component ₹ in Crores Currency with the public 4,35,656.6 ‘Other’ deposits with RBI 12,34.2 Saving deposits with post office saving banks 647.7 Net time deposits with the banking system                                                ‘ 5,14,834.3 Demand deposits with banks 2,74,254.9

M1 = Currency Notes and Coins with the people + demand deposits with the banking system (currency and saving deposit accounts) + Other deposits with the RBI
= 4,35,656.6 + 2,74,254.9 + 1,234.2 = 7,11,145.7 Crores
M2 = M1 + Saving deposit with Post Office Saving Bank
= 7,11,145.7 + 647.7 = 7,11,793.4 Crores

Important Questions

Question 1.
(a) Calculate M if Velocity 19, Price 108.5 and Volume of transactions 120 billion.
(b) What will be the effect on money supply if velocity is 25?
(a) MV = PT,
M × 19 = 108.5 × 120
M = 685.26 billion

(b) MV = PT,
M × 25 = 108.5 × 120
M = 520.8 billion
Effect: Money supply will decrease by 164.46 (685.26 – 520.8) billion.

Question 2.
(a) Calculate velocity of money, Money Supply 5,000 billion, Price 110 and Volume of transaction 200.
(b) What will be the outcome if volume of transaction increases to 225?
(a) MV = PT,
5,000 × V = 110 × 200
V = 4.4

(b) MV = PT,
5,000 × V = 110 × 225
V = 4.95

Question 3.
Calculate Narrow Money (Ml) from the following data:
Currency with public : ₹ 90,000 Crores
Demand Deposits with Banking System : ₹ 2,00,000 Crores
Time Deposits with Banking System : ₹ 2,20,000 Crores
Other Deposits with RBI : ₹ 2,80,000 Crores
Saving Deposits of Post office saving banks : ₹ 60,000 Crores
M1 = Currency with public + Demand Deposits with Banking System + Other Deposits with the RBI
= 90,000 + 2,00,000 + 2,80,000
= 5,70,000 Crores

Question 4.
Compute credit multiplier if the required reserved ratio is 10% and 12.5% for every ₹ 1,00,000 deposited in the banking system. What will be the total credit money created by the banking system in each case?
(a) Credit Multiplier = $$\frac{1}{\text { Required Reserved Ratio }}$$
For RRR 10% = $$\frac{1}{\text { Required Reserved Ratio }}$$ = 1/10% = 10
For RRR 12.5% = $$\frac{1}{\text { Required Reserved Ratio }}$$ = 1/12.5% = 8

(b) Credit creation = Initial deposits × Credit Multiplier
For RRR 10% = 1,00,000 × 10 = 10,00,000
For RRR 12.5% = 1,00,000 × 8 = 8,00,000

Question 5.
Calculate currency with the Public from the following data (₹ Crores)
Notes in Circulation – 24,96,611
Circulation of Rupee Coin – 25,572
Circulation of Small Coins – 743
Cash on Hand with Banks – 98,305
Currency with the Public = 24,96,611 + 25,572 + 743 – 98,305 = 24,24,621

Question 6.
Calculate M2 from the following data: (₹ Crores)
Notes in Circulation – 24,20,964
Circulation of Rupee Coin – 25,572
Circulation of Small Coins – 743
Post Office Saving Bank Deposits – 1,41,786
Cash on Hand with Banks – 97,563
Deposit Money of the Public – 17,76,199
Demand Deposits with Banks – 17,37,692
‘Other’ Deposits with Reserve Bank – 38,507
Total Post Office Deposits – 14,896
Time Deposits with Banks – 1,78,694
M2 = M1 + Post Office Saving Bank Deposits
Ml = (Notes in Circulation + Circulation of Rupee Coin + Circulation of Small Coins – Cash on Hand with Banks) + Deposit Money of the Public
= (24,20,964 + 25,572 + 743 – 97,563) + 17,76,199
= 41,25,915 Crores
M2 = M1+ Post Office Saving Bank Deposits
= 41,25,915 + 1,41,786
= 42,67,701 Crores

Question 7.
If the required reserve ratio is 10 percent, currency in circulation is ₹ 400 billion, demand deposits are ₹ 1,000 billion, and excess reserves total ₹ 1 billion, find the value of money multiplier.
Multiplier ‘m’ = $$\frac{1+c}{r+e+c}$$ = $$\frac{1+0.4}{0.1+0.001+0.4}$$ = 2.79