Macro Economics

Chapter 6

Institution of Money & Modern Economics

Topics Covered
Nature, role and Function of money. Money and Credit. Banking system Working of monetary and credit policy in India.

What Is Money?
Money is the medium of exchange. Money is anything that serves as a commonly accepted medium of exchange or means of payment. The earliest kind of money were commodities, but over time money evolved into paper currencies, bank money.

Nature of Money
Money is a medium of exchange, a unit of account, and a store of value. Money avoids the need for a double coincidence of wants and thus facilitates a wider range of transaction.

Kinds of money
Coins such as gold, silver, copper coins. Paper notes, Fiat money, Credit money or deposits with Banks, Commodity money in the form of grains, cattle etc.

 DOUBLE COINCIDENCE OF WANTS

Ill give you shoes for your Wheat I dont need shoes ,I want cloths

BARTER SYSTEM

Moneys Function
There are the three basic moneys function:
Medium of exchange Standard of value Store of value

The Quantity Theory of Money

Economists use to express the quantity theory of money as the equation: M.V=P.Q M: money supply V: velocity of circulation of money P: the average price level Q: the total output

The Liquidity of Assets

Liquidity is an ability to quickly and easily convert an asset into spendable money at a price near its maximum market value.

Monetary Aggregates
Narrow definitions of money include items that can be spend directly (cash, current accounts). Broad definitions of money include items that cannot be spent directly but can be readily converted into cash.

Credit
Credit is finance made available by one party (lender, seller, or shareholder /owner ) to another. Terms of Credit : The interest rate, collateral, documentation requirement and the mode of payment are the various factors which together comprise the Terms of Credit.

Sources of credit
Formal Sources of Credit -registered by the Government and have to follow its rules and regulations Informal Sources of Credit-small and scattered units which are outside the control of the Government

BANKING SYSTEM
Banking system occupies an important role in nations economy. Banking institution is indispensable in a modern society. It forms the core of the money market in an advanced country.

Money market characterized in 2 segments

1. Organized

2.Unorganised

Organized Sectors
It includes :Commercial Banks Co-operative banks Regional Rulers banks

Unorganized Sectors
It includes : Money Lenders Indigenous bankers

Role of Commercial Banks

Encourage the saving and capital formation Mobilization of saving Optimum utilization of saving Promotes economic growth

Function of a Bank
Receipt of Deposits
(a) Demand deposits or current deposits (b) fixed deposits or time deposits (c) Saving deposits

 Lending of Money (a) Cash Credits (b) Overdrafts (c) Loans and advances (d) Discounting of bills of exchange

Agency Services Collection of bills , promissory notes and cheques Collection of dividends, interest, premium, etc. Purchase and sale of shares and securities Acting as trustee or executor when so nominated Making regular payments such as insurance premiums etc.

 General Services (a) Issuer of letter of credit, travelers cheques, bank drafts, circular notes (b) Safe keeping of valuables in safe deposit vaults (lockers) (c) Supplying trade information and statistics (d) Conducting economic surveys

Banking System
Industrial Development Bank of india
NABARD

Exim bank

IRBI

National Housing Bank

Banking institutions

Commercial banks

Regional rural banks

Co-operative banks

Public sectors banks

Private sectors banks

Indian State bank group

Nationalised banks

Foreign

Commercial banks are essentially dealers in credit. Interest is the price that guides them in making business decision. Credit is provided in an economy also by sources other than banks. These sources vary from country to country in form, price, and allocation. The end users of credit the system creates may also vary much across nations, but they in general include consumers and producers in various sectors of the economy at home and abroad. Credit Creation is not entirely independent of the overall financing environment of a country.

Money Policy & Credit Policy

 Monetary Policy refers to the use of instrument within the control of the Central Bank to the influence the level of aggregate demand for the goods and services or to influence in certain sector of the economy. Monetary policy operates through varying the cost and availability of credit. The level and nature of economic activities such an economy are influenced by the cost and availability of the credit.

Measures of Money Stock

The M1 money supply includes: Assets that serve as media of exchange. M 2 includes all M1 + Saving deposits and small time deposits Assets that act as media of exchange and other very liquid assets that can be converted into media of exchange very easily at little cost. M 3 includes all of M 2 + Large denomination time deposits Other less liquid savings instruments

 L is a broad measure of liquid assets, which includes M 3 +: Short-term treasury securities Commercial papers near money Other liquid assets D includes all forms of credit money: Any future monetary claim that can be used to buy goods and services. There are many forms of credit money.

Instruments of Monetary Policy

Instruments of monetary policy are divided into : 1.General Methods 2.Selective Methods

General Credit Control

The general methods affect the total quantity of credit and affect the economy generally. There are three general or quantitative instruments of credit control. 1. The Bank Rate 2. Open Market Operations 3. Variable Reserve Requirements

Selective Credit Regulation

Selective or Qualitative credit control refers to regulation of credit for specific purpose or branches of economic activity. In India, such controls have been used to prevent speculative hoarding of commodities like food grains and essential raw material to check an under rise in their prices.

Credit Policy
Guidelines addressing how a company evaluates potential customers who wish to buy on credit. Guidelines include credit terms that specify Discounts Interest rate Credit limit.

 Credit policy is the determination of credit standards

and credit analysis. A credit policy of a firm provides the framework to determine Whether or not to extend credit to a customer and How much credit to extend. The credit policy of a firm has two dimensions: Credit standards and Credit analysis.

Credit Standards
It represents the basic criteria or minimum requirement for extending credit to a customer.

The credit standards may be Tight or restrictive - Liberal or non restrictive

Analysis of Credit Information

Quantitative- It is based on the factual information available from the financial statements, the past records of the firm etc. Qualitative: here the information are obtained from the suppliers, bank references and specialist bureau reports.