5. THE MONEY MARKET - mastermindsindia.commastermindsindia.com/MONEY MARKET PART 1.pdf · CA Inter_39e_Economics for Finance_Money Market_____5.2 No.1 for CA/CWA & MEC/CEC MASTER

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5. THE MONEY MARKET

Q.No.1. Define money and explain its characteristics. (A)

Money is at the centre of every economic transaction and plays a significant role in all economies.

Definition of money:In simple terms money refers to assets which are commonly used and accepted as a means ofpayment or as a medium of exchange or of transferring purchasing power.

For policy purposes, money may be defined as the set of liquid financial assets, the variation in thestock of which will have impact on aggregate economic activity.

Nature of Money:1. Purchasing power: Money has generalized purchasing power.

2. General acceptability: Money is generally acceptable in settlement of all transactions and indischarge of other kinds of business obligations including future payments.

3. Liquidity: Money is a totally liquid asset as it can be used directly, instantly, conveniently andwithout any costs or restrictions to make payments

4. Fundamentality: Money provides us with a convenient means to access goods and services.

5. Intrinsic value: Money represents a certain value, but currency which represents money doesnot necessarily have intrinsic value.

6. Legal tenderness: Money as a fiat money (having no intrinsic value) but is used as a medium ofexchange because the government by law made them “legal tender,” (Money serve by law asmeans of payment).

7. Money is not necessarily a physical item: In modern days, money may also constituteelectronic records.

8. Holding form: Money is one of the forms of financial assets which households, firms,governments and other economic units hold in their asset portfolios.

9. Role of money in economic transactions: Unlike other financial assets, money conducts mostof the economic transactions in an economy.

10. Money in order serve its functions it also needs the following characteristics:a) Durable or long-lasting

b) Effortlessly recognizable

c) Difficult to counterfeit i.e. not easily reproducible by people

d) Relatively scarce, but has elasticity of supply


No.1 for CA/CWA & MEC/CEC MASTER MINDSe) Portable or easily transported

f) Possessing uniformity; and

g) Divisible into smaller parts in usable quantities or fractions without losing value

Source: Reserve Bank of India Manual on Financial and Banking Statistics, 2007.

‘There is no unique definition of ‘money’, either as a concept in economic theory or as measured inpractice. Money can be defined for policy purposes as the set of liquid financial assets, the variationin the stock of which could impact on aggregate economic activity. As a statistical concept, moneycould include certain liquid liabilities of a particular set of financial intermediaries or other issuers’.

SIMILAR QUESTIONS:1. Define money.A. Refer Definition2. What is meant by the term “legal tender,”A. Refer 6th point3. List the general characteristics that money should possess?A. Refer 10th point.4. Define money and describe its nature and characteristics

Q.No.2. “Anything that would act as a medium of exchange is not necessarily money.” Commenton it. (B)

For example, a bill of exchange may also be a medium of exchange, but it is not money since it is notgenerally accepted as a means of payment.

Q.No.3. Explain the functions of money. (A)

Money performs many important functions in an economy.

1. Money serves as medium of exchange:a) Money is a convenient medium of exchange as it facilitates easy exchange of goods and

services.b) 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 topurchase goods and services to satisfy our wants.

c) By acting as an intermediary, money increases the ease of trade and reduces the inefficiencyand transaction costs involved in a barter exchange.

d) By decomposing the single barter transaction into two separate transactions of sale andpurchase, money eliminates the need for double coincidence of wants.

e) Money also facilitates separation of transactions both in time and place and this in turnenables us to economize on time and efforts involved in transactions.

2. Measure of Value or Unit of value: Money is an explicitly defined unit of value or unit of account.a) Money is a ‘common measure of value’ or ‘common denominator of value’ or money functions

as a numeraire. (Rupee is the unit of account in India in which the entire money isdenominated).

b) A common unit of account facilitates a system of orderly pricing which is crucial for rationaleconomic choices.

c) The monetary unit is the unit of measurement in terms of which the value of all goods andservices is measured and expressed.



d) The value of each good or service is expressed as price, which is nothing but the number ofmonetary units for which the good or service can be exchanged.

e) Use of money as a unit of account can encourage trade by making it easier for individuals toknow how much one good is worth in terms of another.

f) Goods and services which are otherwise not comparable are made comparable throughexpressing the worth of each in terms of money.

g) Money is a useful measuring rod of value only if the value of money remains constant. (Thevalue of money is linked to its purchasing power. Purchasing power is the inverse of theaverage or general level of prices as measured by the consumer price index).

3. Standard of deferred payment:

a) Money serves as a unit or standard of deferred payment i.e. money facilitates recording ofdeferred promises to pay.

b) Money is the unit in terms of which future payments are contracted or stated.

c) But the variations in the purchasing power of money due to inflation or deflation reduce theefficacy of money in this function.

4. Store of value:

a) People prefer to hold money as an asset i.e. as part of their stock of wealth.

b) 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 efficientlyperform its medium of exchange function.

c) Money also functions as a permanent store of value.

d) There are many other assets such as government bonds, deposits and other securities, land,houses etc. which also store value.

e) Money is the only asset which has perfect liquidity.

f) Money also commands reversibility as its value in payment equals its value in receipt.

g) The effectiveness of an asset as a store of value depends on the degree and certainty withwhich the asset maintains its value over time.

h) Hence, in order to serve as a permanent store of value in the economy, the purchasing poweror the value of money should either remain stable or should monotonically rise over time.

SIMILAR QUESTIONS:1. Write notes on the function of money as a medium of exchange.A. Refer 1st point

2. Outline how money is useful as a ‘common denominator of value’.A. Refer 2nd point

3. Examine the relationship between purchasing power of money and general price level.A. Refer h) in 2nd point

4. Critically examine money’s function as standard of deferred payment.A. Refer 3rd point

5. Explain the functions performed by money.Copyrights Reserved

To MASTER MINDS, Guntur


No.1 for CA/CWA & MEC/CEC MASTER MINDS

Q.No.4. Explain the concept of ‘demand for money’. (B)

If people desire to hold money, there is demand for money.

DEMAND FOR MONEY: The demand for money is a decision about how much of one’s given stockof wealth should be held in the form of money rather than as other assets such as bonds. Although itgives little or no return, households as well as firms hold money because it is liquid and offers themost convenient way to accomplish their day to day transactions.

1. The demand for money is defined as derived demand (as it is demanded for its purchasingpower).

2. People demand money because they wish to have command over real goods and services withthe use of money.

3. Demand for money is actually demand for liquidity and demand to store value.

4. Demand for money has an important role in the determination of interest, prices and income in aneconomy

SIMILAR QUESTIONS:1. Why do we say that money demand is derived demand?A. Refer the 4 points

2. Why is it important to study about demand for money?A. Refer 4th point

Q.No.5. List out the important variables on which demand for money depends on? (A)

The quantity of nominal money or how much money people would like to hold in liquid form dependson many factors, such as:

1. Income: Higher the income of individuals, higher the expenditure and richer people hold moremoney to finance their expenditure.

2. General level of prices: The quantity is directly proportional to the prevailing price level; higherthe prices, higher should be the holding of money.

3. Rate of interest: Higher the interest rate, higher would be opportunity cost of holding cash andlower the demand for money

4. The degree of financial innovation: Innovations such as internet banking, application basedtransfers and automatic teller machines reduce the need for holding liquid money.

5. Real GDP: Just as households do, firms also hold money essentially for the same basic reasons.

SIMILAR QUESTION:1. Explain how higher the interest rate affect the demand for money.A. Refer 3rd point

Q.No.6. Describe the Classical Approach of the Quantity Theory of Money (QTM) given byIrving Fisher. (A)

Classical Approach: The Quantity Theory of Money (QTM)Theory: The quantity theory of money

Nature of theory: One of the oldest theories in Economics

First propounded by: Irving Fisher (of Yale University)



Publication: ‘The Purchasing Power of Money’ (1911)Supported by: Neoclassical economistsDemonstration on QTM: “There is strong relationship between money and price level.” The quantity of money is the main determinant of the price level or the value of money. The changes in the general level of commodity prices or changes in the value or purchasing

power of money are determined first and foremost by changes in the quantity of money incirculation.

Fisher’s version of Quantity Theory of Money:Fisher termed classical approach of QTM as ‘equation of exchange’ or ‘transaction approach’ andstated as follows:

MV = PTWhere,M= the total amount of money in circulation (on an average) in an economyV = transactions velocity of circulation i.e. the average number of times across all transactions a unitof money(say Rupee) is spent in purchasing goods and servicesP = average price level (P= MV/T)T = the total number of transactions.

Modification by fisher in his equation of exchange:Fisher extended the equation of exchange to include demand (bank) deposits (M1) and their velocity(V1) in the total supply of money. Thus, the equation of exchange becomes:

MV + M1V1 = PT

Where, M1 = the total quantity of credit money

V1 = velocity of circulation of credit money

Assumptions:a) Velocity of money in circulation (V) and the velocity of credit money (V1) remain constant.

b) T is a function of national income. Since full employment prevails, the volume of transactions T isfixed in the short run.

Explanation:a) The total supply of money in the community consists of the quantity of actual money (M) and its

velocity of circulation (V).

b) The total volume of transactions (T) multiplied by the price level (P) represents the demand formoney.

c) The demand for money (PT) is equal to the supply of money (MV + M1V1).

d) In any given period, the total value of transactions made is equal to PT and the value of moneyflow is equal to MV+ M1V1.

e) Thus, there is an aggregate demand for money for transactions purpose and more the number oftransactions people want, greater will be the demand for money.

Note: Fisher did not specifically mention anything about the demand for money; but the same isembedded in his theory as dependent on the total value of transactions undertaken in the economy.

SIMILAR QUESTIONS:1. Describe the main postulates of quantity theory of money.A. Refer assumptions

2. ‘The quantity theory of money is not a theory about money at all, rather it is a theory ofthe price-level’ Elucidate



Q.No.7. Define Neo classical Approach: The Cambridge approach. (B)

The Neo classical Approach: The Cambridge approachIn the early 1900’s, Cambridge Economists Alfred Marshall, A.C. Pigou, D.H. Robertson and JohnMaynard Keynes (then associated with Cambridge) put forward a fundamentally different approach toquantity theory, known as neoclassical theory or cash balance approach.

The Cambridge approach:The Cambridge version holds that money increases utility in the following two ways:

1. Enabling the possibility of split-up of sale and purchase to two different points of timerather than being simultaneous:It represents transaction motive (as Fisher envisaged).

2. Being a hedge against uncertainty:It points out that role of money as a temporary store of wealth. Since sale and purchase ofcommodities by individuals do not take place simultaneously, they need a ‘temporary abode’ ofpurchasing power as a hedge against uncertainty.

As demand for money also involves a precautionary motive in Cambridge approach, one can saythat money is demanded for itself (as money gives utility in its store of wealth and precautionarymodes).

Explanation:

The quantity of money will be demanded depends partly on income and partly on other importantfactors such as wealth and interest rates. The higher the income, the greater the quantity ofpurchases and as a consequence greater will be the need for money as a temporary abode of valueto overcome transactions costs.

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 explains that the demand for money (M) equals k proportion of the total money income.

Conclusion:

The neoclassical theory changed the focus of the quantity theory of money to money demand andhypothesized that demand for money is a function of only money income.

SIMILAR QUESTION:

1. Name the two ways that which money increases utility as per Cambridge version?

A. Refer points 1 & 2 Copyrights Reserved




Q.No.8. Define the Keynesian Theory of Demand for Money. (A)

Keynesian theory of demand for money is known as ‘Liquidity Preference Theory’. ‘Liquiditypreference’, a term that was coined by John Maynard Keynes in his masterpiece ‘The GeneralTheory of Employment, Interest and Money’ (1936), denotes people’s desire to hold money ratherthan securities or long-term interest-bearing investments.According to Keynes, people hold money (M) in cash for three motives:1. Transactions motive,2. Precautionary motive, and3. Speculative motiveAccording to Keynes, the sum of the transaction and precautionary demand, and the speculativedemand, is the total demand for money.1. The Transactions Motive:

a) The transactions motive for holding cash relates to ‘the need for cash for current transactionsfor personal and business exchange’.

b) The need for holding money arises because there is lack of synchronization between receiptsand expenditures.

c) The transaction motive is further classified into income motive and business (trade) motive(i.e. the requirement of individuals and businesses respectively to bridge the time gapbetween receipt of income and planned expenditures).

d) Keynes did not consider the transaction balances as being affected by interest rates.

e) The transactions demand for money is a direct proportional and positive function of the levelof income and is stated as follows:

Lr = kYWhere,Lr is the transactions demand for money,k is the ratio of earnings which is kept for transactions purposesY is the earnings.Keynes considered the aggregate demand for money for transaction purposes as the sum ofindividual demand and therefore, the aggregate transaction demand for money is a function ofnational income.

2. The Precautionary Motive:a) Many unforeseen and unpredictable contingencies involving money payments occur in our

day to day life. Individuals as well as businesses keep a portion of their income to financesuch unanticipated expenditures.

b) The amount of money demanded under the precautionary motive depends on the size ofincome, prevailing economic as well as political conditions and personal characteristics of theindividual (such as optimism/ pessimism, farsightedness etc.)

c) Keynes regarded the precautionary balances just as balances under transactions motive asincome elastic and by itself not very sensitive to rate of interest.

3. The Speculative Demand for Money:a) The speculative motive reflects people’s desire to hold cash in order to be equipped to exploit

any attractive investment opportunity requiring cash expenditure.

b) According to Keynes, people demand to hold money balances to take advantage of the futurechanges in the rate of interest, which is the same as future changes in bond prices.

c) It is implicit in Keynes theory, that the ‘rate of interest’, i, is really the return on bonds.


No.1 for CA/CWA & MEC/CEC MASTER MINDSAssumptions:i) The expected return on money is zero

ii) The expected returns on bonds are of two types, namely the interest payment and the expectedrate of capital gain.

The speculative demand for money and interest are inversely related:The market value of bonds and the market rate of interest are inversely related.

i) If the current rate of interest is higher than the critical rate of interest, a typical wealth-holderwould hold in his asset portfolio only government bonds

ii) If the current rate of interest is lower than the critical rate of interest, his asset portfolio wouldconsist wholly of cash.

iii) When the current rate of interest is equal to the critical rate of interest, a wealth-holder isindifferent to holding either cash or bonds.

Conclusion:An increase in income increases the transaction and precautionary demand for money and a rise inthe rate of interest decreases the demand for speculative demand money.

SIMILAR QUESTIONS:1. Describe the Keynesian view of different motives of holding cash2. Explain the Keynesian theory of demand for money. What motives did Keynes ascribe to

demand for money? Illustrate your answer.3. Explain the Transactions Motive in the Keynesian theory of demand for money.A. Refer 1st point

4. Explain the Precautionary Motive in the Keynesian theory of demand for money

A. Refer 2nd point

5. Explain the Speculative Motive in the Keynesian theory of demand for money

A. Refer 3rd point

Q.No.9. Explain graphically the speculative demand for money of individuals given by Keynes.(B)

The speculative demand for money of individuals can be diagrammatically presented as follows.Individual’s Speculative Demand for Money:

1. The discontinuous portfolio decision of a typical individual investor is shown in the figure above.

2. When the current rate of interest rn is higher than the critical rate of interest rc, the entire wealthis held by the individual wealth-holder in the form of government bonds.



3. If the rate of interest falls below the critical rate of interest rc, the individual will hold his entirewealth in the form of speculative cash balances.

Q.No.10. Explain graphically the aggregate speculative demand for money given by Keynes.(B)

Aggregate Speculative Demand for Money: When we go from the individual speculative demandfor money to the aggregate speculative demand for money, the discontinuity of the individual wealth-holder's demand curve for the speculative cash balances disappears and we obtain a continuousdownward sloping demand function showing the inverse relationship between the current rate ofinterest and the speculative demand for money as shown in figure below.

Q.No.11. Explain Post-keynesian developments in the theory of demand for money. (B)

Post-keynesian developments in the theory of demand for money:Most post-Keynesian theories of demand for money emphasize the store-of-value or the assetfunction of money.

Inventory Approach to Transaction Balances:a) Baumol (1952) and Tobin (1956) developed a deterministic theory of transaction demand for

money, known as Inventory Theoretic Approach.

b) In this approach, money or ‘real cash balance’ was essentially viewed as an inventory held fortransaction purposes.

i) Assumptions of Baumol’s theory: Inventory models assume that there are two media forstoring value: money and an interest-bearing alternative financial asset. (There is a fixed costof making transfers between money and the alternative assets e.g. brokerage charges.)

ii) Application of Baumol’s theory: He used business inventory approach to analyze thebehaviour of individuals. Just as businesses keep money to facilitate their businesstransactions, people also hold cash balance which involves an opportunity cost in terms of lostinterest. Therefore, they hold an optimum combination of bonds and cash balance, i.e., anamount that minimizes the opportunity cost.

iii) Baumol’s propositions of holdings:

In his theory of transaction demand for money hold that receipt of income, say Y takes placeonce per unit of time but expenditure is spread at a constant rate over the entire period oftime.

Excess cash over and above what is required for transactions during the period underconsideration will be invested in bonds or put in an interest-bearing account.


No.1 for CA/CWA & MEC/CEC MASTER MINDS Money holdings on an average will be lower if people hold bonds or other interest yielding

assets.

The higher the income, the higher is the average level or inventory of money holdings. The levelof inventory holding also depends also upon the carrying cost, for example brokerage fee.

The individual will choose the number of times the transfer between money and bondstakes place in such a way that the net profits from bond transactions are maximized.

The average transaction balance (money) holding is a function of the number of times thetransfer between money and bonds takes place.

The more the number of times the bond transaction is made, the lesser will be theaverage transaction balance holdings.

The choice of the number of times the bond transaction is made determines the split ofmoney and bond holdings for a given income.

iv) Effect of Brokerage fee (i.e. carrying cost):

The inventory-theoretic approach also suggests that the demand for money and bondsdepend on the cost of making a transfer between money and bonds e.g. the brokeragefee.

An increase the brokerage fee raises the marginal cost of bond market transactions andconsequently lowers the number of such transactions.

The increase in the brokerage fee raises the transactions demand for money and lowersthe average bond holding over the period.

This result follows because an increase in the brokerage fee makes it more costly toswitch funds temporarily into bond holdings.

An individual combines his asset portfolio of cash and bond in such proportions that hiscost is minimized.

SIMILAR QUESTIONS:1. Define ‘real cash balance’. Describe the Inventory Theoretic Approach to demand for money.2. List out the factors that determine the demand for money in the Baumol-Tobin analysis

of transactions demand for money? How does a change in each factor affect thequantity of money demanded?

3. Examine the influence of different variables on demand for money according to InventoryTheoretic Approach?

A. Refer points 3 & 4

Q.No.12. Explain Friedman's Restatement of the Quantity Theory. (A)

1. Friedman's Restatement of the Quantity Theory:Milton Friedman (1956) extended Keynes’ speculative money demand within the framework ofasset price theory.

Friedman treats the demand for money as nothing more than the application of a more generaltheory of demand for capital assets.

Demand for money is affected by the same factors as demand for any other asset, namely

a) Permanent income.

b) Relative returns on assets. (Which incorporate risk)

2. Permanent income: Friedman maintains that it is permanent income and not current income asin the Keynesian theory that determines the demand for money.



3. Relative returns on assets:Permanent income which is Friedman’s measure of wealth is the present expected value of allfuture income.

To Friedman, money is a good as any other durable consumption good and identifies thefollowing 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 thediscount rate,

b) Is defined as the average return on the five asset classes in the monetarist theory world,namely money, bonds, equity, physical capital and human capital.

c) Is positively related to the price level, P. If the price level rises the demand for moneyincreases and vice versa.

d) Rises if the opportunity costs of money holdings (i.e. returns on bonds and stock) decline and viceversa.

e) Is influenced by inflation, a positive inflation rate reduces the real value of money balances,thereby increasing the opportunity costs of money holdings.

SIMILAR QUESTIONS:1. What factors determine demand for money in Friedman’s modern quantity theory?

How does each of eth factors affect demand for money?A. Refer points 1, 2 & 3

2. To what extent does Friedman's Restatement of the Quantity Theory explain thedemand for money?

A. Refer points a to e

Q.No.13. Explain the Demand for Money as Behavior toward Risk in the words of Tobin. (B)

The Demand for Money as Behavior toward Risk in the words of Tobin:In his classic article, ‘Liquidity Preference as Behavior towards Risk’ (1958), Tobin established thatthe theory of risk-avoiding behavior of individuals.

It provided the foundation for the liquidity preference and for a negative relationship between thedemand for money and the interest rate.

1) The risk-aversion theory is based on the principles of portfolio management.

2) Optimal Portfolio Structure: It is determined by

a) The risk/reward characteristics of different assets

b) The taste of the individual in maximizing his utility consistent with the existing opportunities

3) Analysis: The individual's portfolio allocation between money and bond holdings is the demandfor money which is considered as a store of wealth. It also indicates that uncertainty about futurechanges in bond prices, and hence the risk involved in buying bonds, may be a determinant ofmoney demand.

4) Hypothesis: An individual would hold a portion of his wealth in the form of money in the portfolio(because the rate of return on holding money was more certain than the rate of return on holdinginterest earning assets and entails no capital gains or losses).

5) It is riskier to hold alternative assets vis-à-vis holding interest just money alone: It isbecause government bonds and equities are subject to market price volatility, while money is not.

6) Return on bonds: Bonds pay an expected return of r, but as asset, they are unlike moneybecause they are risky; and their actual return is uncertain.


No.1 for CA/CWA & MEC/CEC MASTER MINDS7) Individual will be willing to face the risk: It is so because the expected rate of return from the

alternative financial assets exceeds that of money.

8) Rationality: The rational behaviour of a risk-averse economic agent induces him to hold anoptimally structured wealth portfolio which is comprised of both bonds and money.

9) Risk aversion: The overall expected return on the portfolio would be higher if the portfolio wereall bonds, but an investor who is ‘risk-averse’ will be willing to exercise a trade- off and sacrifice tosome extent the higher return for a reduction in risk.

10) Effect of interest rate: The amount of money held as an asset depends on the level of interestrate. An increase in the interest rate will improve the terms on which the expected return onthe portfolio can be increased by accepting greater risk. Thus the individual will increase theproportion of wealth held in the interest-bearing asset, say bonds, and will decrease the holding ofmoney. (i.e. the demand for money as a store of wealth will decline with an increase in theinterest rate.)

SIMILAR QUESTIONS:1. ‘Risk-avoiding behavior of individuals provided the foundation for the liquidity

preference and for a negative relationship between the demand for money and theinterest rate’ Elucidate with examples.

Q.No.14. Define money supply and what are concepts involved in it. (B)

Q.No.15. Define Money supply. Provide the two important things about any measure of moneysupply. (A)

1) Money Supply: The term money supply denotes the total quantity of money available to thepeople in an economy. The quantity of money at any point of time is a measurable concept.

2) Two important things about any measure of money supply:The supply of money is a stock variable i.e. it refers to the total amount of money at any particularpoint of time.

It is the change in the stock of money (increase or decrease per month or year,), which is a flow.

Note: The stock of money always refers to the stock of money available to the ‘public’ as a means ofpayments and store of value. This is always smaller than the total stock of money that really exists inan economy.

SIMILAR QUESTIONS:1. Define money supply.

Copyrights Reserved




A. Refer 1st point

Q.No.16. Define Public, Government and Banking system in terms of money supply. (B)

1. PUBLIC: The term ‘public’ is defined to include all economic units (households, firms andinstitutions) except the producers of money (i.e. the government and the banking system).

a) The word ‘public’ is inclusive of all local authorities, non-banking financial institutions, and non-departmental public-sector undertakings, foreign central banks and governments and theInternational Monetary Fund which holds a part of Indian money in India in the form of depositswith the RBI.

b) In the standard measures of money, interbank deposits and money held by the governmentand the banking system are not included.

2. Government:The government includes the central government and all state governments and local bodies.

3. Banking system:The banking system means the Reserve Bank of India and all the banks that accept demanddeposits (i.e. deposits from which money can be withdrawn by cheque mainly CASA deposits).

SIMILAR QUESTION:1. Describe the different components of money supply.

Q.No.17. What is the rationale of measuring money supply in an economy? (B)

Empirical analysis of money supply is important for two reasons:1. It facilitates analysis of monetary developments in order to provide a deeper understanding of the

causes of money growth.

2. It is essential from a monetary policy perspective as it provides a framework to evaluate whetherthe stock of money in the economy is consistent with the standards for price stability and tounderstand the nature of deviations from this standard.

The central banks all over the world adopt monetary policy to stabilise price level and GDP growthby directly controlling the supply of money. This is achieved mainly by managing the quantity ofmonetary base. The success of monetary policy depends to a large extent on the controllability ofmoney supply and the monetary base.

SIMILAR QUESTION:1. List out the need for and rationale of measuring money supply

Q.No.18. Explain the sources of money supply in an economy? (A)

The supply of money in the economy depends on:

1. The decision of the central bank based on the authority conferred on it, (Monetary authority).

2. The supply responses of the commercial banking system of the country to the changes in policyvariables initiated by the central bank to influence the total money supply in theeconomy.(Banking system)

1. Monetary authority:a) The central banks of all countries are empowered to issue currency and, therefore, the central

bank is the primary source of money supply in all countries.

b) In effect, high powered money issued by monetary authorities is the source of all other forms


No.1 for CA/CWA & MEC/CEC MASTER MINDSof money.

c) The currency issued by the central bank is ‘fiat money’ and is backed by supporting reservesand its value is guaranteed by the government.

d) The currency issued by the central bank is, in fact, a liability of the central bank and thegovernment.

e) In principle, currency must be backed by an equal value of assets mainly consisting of goldand foreign exchange reserves.

f) In practice, most countries have adopted a ‘minimum reserve system ’wherein the centralbank is empowered to issue currency to any extent by keeping only a certain minimumreserve of gold and foreign securities.

2. Banking System:a) The total supply of money in the economy is also determined by the extent of credit created

by the commercial banks in the country.b) Banks create money supply in the process of borrowing and lending transactions with the

public. Money so created by the commercial banks is called 'credit money’.Note: The high powered money and the credit money broadly constitute the most common measureof money supply, or the total money stock of a country.SIMILAR QUESTIONS:1. Elucidate the different sources of money supply2. Explain the nature of currency issue under minimum reserve system.A. Refer f) in 1st point3. Define ‘credit money’.A. Refer b) in 2nd point

Q.No.19. Explain the concept of measurement of money supply. (A)

The alternative measures of money supply prepared and published by the RBI. Since July 1935, theRBI has been compiling and disseminating monetary statistics.Measurement of Money Supply:Till 1967-68, the RBI used to publish only a single ‘narrow measure of money supply’ (M1) definedas the sum of currency and demand deposits held by the public.From 1967-68, a 'broader' measure of money supply, called 'aggregate monetary resources' (AMR)was additionally published by the RBI.From April 1977, following the recommendations of the Second Working Group on Money Supply(SWG), the RBI has been publishing data on four alternative measures of money supplydenoted by M1, M2, M3 and M4 besides the reserve money.The respective empirical definitions of these measures are:

M1 = Currency notes and coins with the people + demand deposits of banks (Current andSaving deposit accounts) + other deposits of the RBI.M2 = M1 + savings deposits with post office savings banks.M3 = M1 + net time deposits with the banking system.M4 = M3 + total deposits with the Post Office Savings Organization (excluding NationalSavings certificate).

Note: The RBI has specified four measures of money stock in the descending order of liquidity, M1

being the most liquid and M4 the least liquid of the four measures.

SIMILAR QUESTION:



1. Illustrate the various measures of money supply

Q.No.20. Explain the components of Narrow money (A)

M1 = Currency notes and coins with the people + demand deposits of banks (Current andSaving deposit accounts) + other deposits of the RBI.

Components of Narrow Money:1. Currency: It consists of paper currency as well as coins.

2. Demand deposits: The demand deposits comprise the current-account deposits and the demanddeposit portion of savings deposits, all held by the public. These are also called CASA depositsand these are cheapest sources of finance for a commercial bank.

a) It should be noted that it is the net demand deposits of banks, and not their total demanddeposits that get included in the measure of money supply.

b) The total deposits include both deposits from the public as well as interbank deposits. Moneyis deemed as something held by the ‘public’. Since interbank deposits are not held by thepublic, they are netted out of the total demand deposits to arrive at net demand deposits.

3. 'Other deposits’ of the RBI: These are deposits other than those held by the government (theCentral and state governments), and includea) Demand deposits of quasi- government institutions, other financial institutions,b) Balances in the accounts of foreign central banks and governments,c) Accounts of international agencies such as IMF and the World Bank.

Empirically, whatever the measure of money supply, these 'other deposits' of the RBIconstitute a very small proportion (less than one per cent) of the total money supply.

SIMILAR QUESTIONS:

1. List the components of M1.2. What is the rationale behind inclusion of net demand deposits of banks in money

supply measurement?A. Refer a) and b) in 2nd point

Q.No.21. Explain the new monetary aggregates provided on the recommendations of theWorking Group on Money (1998). (A)

Following the recommendations of the Working Group on Money (1998), the RBI has startedpublishing a set of four new monetary aggregates on the basis of the balance sheet of the bankingsector in conformity with the norms of progressive liquidity. The new monetary aggregates are:

Reserve Money = Currency in circulation + Bankers’ deposits with the RBI + Other deposits with the RBI = 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 LiabilitiesNM1 = Currency with the public + Demand deposits with the banking system + ‘Other’deposits with the RBI.NM2 = NM1 + Short-term time deposits of residents (including and up to contractual maturityof one year).NM3 = NM2 + Long-term time deposits of residents + Call/Term funding from financial


No.1 for CA/CWA & MEC/CEC MASTER MINDSinstitutions

SIMILAR QUESTION:1. Classify the new monetary aggregates based on the Working Group on Money (1998)

provided by the RBI.

Q.No.22. Define the terms Narrow money and Reserve money. Compare the both terms. (B)

a) Narrow Money: Narrow money (M1) is defined as the sum of currency held by the public, demanddeposits of the banks and other deposits of RBI.

b) Reserve money:i) Reserve money is comprised of the currency held by the public, cash reserves of banks and

other deposits of RBI.

ii) Reserve money, also known as central bank money, base money or high-powered money.

iii) Reserve money determines the level of liquidity and price level in the economy and, therefore,its management is of crucial importance to stabilize liquidity, growth, and price level in aneconomy.

c) On comparison of M1 and reserve money: M1 includes the demand deposits while reservemoney includes the cash reserves of banks.

Note: Reserves are commercial banks’ deposits with the central bank for maintaining cash reserveratio (CRR) and as working funds for clearing adjustments.

SIMILAR QUESTIONS:1. Define ‘Reserve Money’.A. Refer point b

2. Write a note on two major components Reserve money?A. Refer point b

3. Distinguish between M1 and M2.A. Refer point c

Q.No.23. State the macroeconomic liquidity aggregates measured by Central bank in additionto the monetary aggregates? (B)

Liquidity aggregates includes:i) The instruments issued by the banking system which are included in ‘money’.

ii) The instruments which are close substitutes of money but are issued by the non-banking financialinstitutions.

L1 = NM3 + All deposits with the post office savings banks (excluding National SavingsCertificates).

L2 = L1 +Term deposits with term lending institutions and refinancing institutions (FIs) +Term borrowing by FIs + Certificates of deposit issued by FIs.

L3 = L2 + Public deposits of non-banking financial companies

SIMILAR QUESTION:1. Write a note on the liquidity aggregates compiled by RBI

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Q.No.24. Name the two alternate theories in respect of determination of money supply? Onwhich determinant of money is current practice is based upon? (B)

The two alternate theories in respect of determination of money supply:1) The money supply is determined exogenously by the central bank.

2) The money supply is determined endogenously by changes in the economic activities which affectpeople’s desire to hold currency relative to deposits, rate of interest, etc.

The current practice is to explain the determinants of money supply based on ‘money multiplierapproach’.

SIMILAR QUESTION:

1. Name the different determinants of money supply

Q.No.25. Briefly explain the concept of money multiplier? (A)

MONEY MULTIPLIER APPROACH:‘Money multiplier approach’ focuses on the relation between the money stock and money supply interms of the monetary base or high-powered money.

This approach holds that total supply of nominal money in the economy is determined by the jointbehaviour of the central bank, the commercial banks and the public.1. Money Supply:

The money supply is defined asM = m X MBWhere M is the money supply, m is money multiplier and MB is the monetary base or highpowered money.

2. Money multiplier:

BaseMonetarySupplyMoney=(m)MultiplierMoney

a) Money multiplier m is defined as a ratio of changes in the money supply to a given change inthe monetary base.

b) It denotes by how much the money supply will change for a given change in high-poweredmoney.

c) The multiplier indicates what multiple of the monetary base is transformed into money supply.Note: As a rule, an increase in the monetary base that goes into currency is not multiplied, whereasan increase in monetary base that goes into supporting deposits is multiplied.

SIMILAR QUESTIONS:1. Define ‘money multiplier’A. Refer 2nd point

2. What is the nature of relationship between money multiplier and the money supply?3. Explain the money multiplier approach to money supply?

Q.No.26. How the money multiplier approach can determine the supply of money? (A)

The money multiplier approach to money supply propounded by Milton Friedman and Anna Schwartz,(1963) considers three factors as immediate determinants of money supply, namely:


No.1 for CA/CWA & MEC/CEC MASTER MINDS1. The stock of high-powered money (H): (behaviour of the central bank)

2. The ratio of reserves to deposits, e = {ER/D} : (behaviour of the commercial banks)

3. The ratio of currency to deposits, c ={C/D}: (behaviour of the general public)

1. The Behaviour of the Central Bank:The behaviour of the central bank which controls the issue of currency is reflected in the supply ofthe nominal high-powered money.

Money stock is determined by the money multiplier and the monetary base is controlled bythe monetary authority.

If the behaviour of the public and the commercial banks remains unchanged over time, the totalsupply of nominal money in the economy will vary directly with the supply of the nominal high-powered money issued by the central bank.

2. The Behaviour of Commercial Banks:By creating credit, the commercial banks determine the total amount of nominal demand deposits.

I. Reserve ratio: If the required reserve ratio on demand deposits increases while all the othervariables remain the same, more reserves would be needed. Then banks must contract theirloans, causing a decline in deposits and also money supply. (Vice versa)

II. Cash reserves:In the commercial banking system when the actual reserves ratio is greater than the requiredreserve ratio (large portion of SLR in the form of cash reserves) the additional units of high-powered money goes into ‘excess reserves’ of the commercial banks. These excess reservesdo not lead to any additional loans or creation of money.

Therefore, if the central bank injects money into the banking system and these are held asexcess reserves by the banking system, there will be no effect on deposits or currency andhence no effect on money supply.

III. Costs and benefits of holding excess reserves: (Market interest rates and Expected depositoutflows)

If the costs of holding the excess reserves rise, then the level of excess reserves falls.

If the benefits of holding excess reserves rise, then the level of excess reserves rises.

IV. cost of holding excess reserves is in terms of its opportunity cost: (Market interest rate):If interest rate increases, the opportunity cost of holding excess reserves rises because thebanks have to sacrifice possible higher earnings and hence the desired ratio of excessreserves to deposits falls and vice-versa. (The banking system's excess reserves ratio e isnegatively related to the market interest rate.)

V. Cost of holding excess reserves is in terms of expected deposit outflows:If expected deposit outflows increase, banks want more assurance against this possibility andwill increase the excess reserves ratio and vice-versa.

VI. Money supply when subject to shocks:Money is mostly held in the form of deposits with CBs. Therefore, money supply becomesubject to ‘shocks’ which may present variations overtime either cyclically and morepermanently.

For instance, in times of financial crises, banks may be unwilling to lend to the small andmedium scale industries who may become credit constrained facing a higher risk premia ontheir borrowings. The rising interest rates on bank credit to the commercial sector reflectinghigher risk premia can co-exist with the lowering of policy rates by the central bank. The lowercredit demand can lead to a sharp deceleration in monetary growth at a time when the centralbank pursues an easy monetary policy.



3. The Behaviour of the Public:a) The public, by their decisions in respect of the amount of nominal currency in hand can

influence the amount of the nominal demand deposits of the commercial banks.

b) The behaviour of the public influences bank credit through the decision on ratio of currency tothe money supply designated as the ‘currency ratio’.

c) If many people decide to keep more money in their pockets and less money in banks thencurrency ratio increases.

d) But demand deposits undergo multiple expansions while currency in hands does not. Hence,when bank deposits are being converted into currency, banks can create only less creditmoney.

e) The overall level of multiple expansion declines, and therefore, money multiplier also falls. (i.e.money multiplier and money supply are negatively related to the currency ratio c.)

f) The currency-deposit ratio (c) is related to the level of economic activities or the GDP growthand is influenced by the degree of financial sophistication (in terms of ease and access tofinancial services, availability of a richer array of liquid financial assets, financial innovations,institutional changes etc).

g) An increase in TD/DD ratio (Time deposit/ demand deposit ratio) means that greateravailability of free reserves and consequent enlargement of volume of multiple depositexpansion and monetary expansion.

SIMILAR QUESTIONS:1. Explain the concept of money multiplier and bring out its impact on money supply.2. Briefly explain the stock of high-powered money (H) or the behaviour of the central bank in

the money supply.A. Refer 1st point3. Briefly explain the ratio of reserves to deposits (e) or the behaviour of the commercial

banks in the money supply.A. Refer 2nd point

4. Briefly explain the ratio of currency to deposits (c) or the behaviour of the generalpublic in the money supply.

A. Refer 3rd point

5. Describe with illustrations how changes in high powered money, required reserves,excess reserves and currency ratio, influence the money supply in an economy?

A. Refer 2nd point

Q.No.27. State the effect of government expenditure on money supply? (A)

Effect of Government Expenditure on Money Supply:Whenever the central and the state governments’ cash balances fall short of the minimumrequirement, they are eligible to avail of a facility called Ways and Means Advances (WMA)/overdraft(OD) facility.a) When the RBI lends to the governments under WMA /OD, it results in the generation of excess

reserves (i.e., excess balances of commercial banks with the Reserve Bank).b) This happens because when government incurs expenditure, it involves debiting the government

balances with the RBI and crediting the receiver (for e.g., salary account of governmentemployee) account with the commercial bank.

c) The excess reserves thus created can potentially lead to an increase in money supplythrough the money multiplier process.


No.1 for CA/CWA & MEC/CEC MASTER MINDSThe Credit Multiplier or the deposit multiplier or the deposit expansion multiplier:It describes the amount of additional money created by commercial bank through the process oflending the available money it has, in excess of the central bank's reserve requirements.

a) The deposit multiplier is, thus inextricably tied to the bank's reserve requirement.

b) This measure tells us how much new money will be created by the banking system for a givenincrease in the high- powered money.

c) It reflects a bank's ability to increase the money supply.

d) The credit multiplier is the reciprocal of the required reserve ratio.

RatioReserveRequired1multiplierCredit

e) The existence of the credit multiplier is the outcome of fractional reserve banking.

f) It explains how increase in money supply is caused by the commercial banks’ use ofdepositors’ funds to lend money. When a bank uses the deposited money for lending, the bankgenerates another claim on a given amount of deposited money.

Q.No.28. Why the deposit multiplier and the money multiplier though closely related are notidentical? (B)

Though the deposit multiplier and the money multiplier are closely related but are not identicalbecause:

i) Generally banks do not lend out all of their available money but instead maintainreserves at a level above the minimum required reserve.

ii) All borrowers do not spend every Rupee they have borrowed. They are likely to convert someportion of it to cash.

Q.No.29. Draw the tree diagram representing the instruments of monetary policy. (B)

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Q.No.30. Define Monetary Policy. (B)

Monetary policy:Monetary policy refers to the use of monetary policy instruments which are at the disposal of thecentral bank to regulate the availability, cost and use of money and credit to promote economicgrowth, price stability, optimum levels of output and employment, balance of paymentsequilibrium, stable currency or any other goal of government's economic policy.

Monetary policy encompasses all actions of the central bank which are aimed at directlycontrolling the money supply and indirectly at regulating the demand for money.

Q.No.31. Elucidate different components of the monetary policy framework. (B)

The central bank, in its execution of monetary policy, functions within an articulated monetarypolicy framework which has three basic components, viz.

i) The objectives of monetary policy,

ii) The analytics of monetary policy which focus on the transmission mechanisms, and

iii) The operating procedure which focuses on the operating targets and instruments.

Q.No.32. What are the objectives of Monetary Policy in India? (A)

Objectives of Monetary Policy in India:The objectives of monetary policy generally coincide with the overall objectives of economic policyand they provide explicit guidance to policy makers. They are

1) Maintaining price stability (a necessary precondition for sustainable growth)

2) Ensuring adequate flow of credit to the productive sectors of the economy

3) Economic growth

Multiple objectives which are equally desirable in the recent years are:

1) Rapid economic growth,

2) Debt management,

3) Moderate long-term interest rates,

4) Exchange rate stability

5) External balance of payments equilibrium

Considerations of financial and exchange rate stability have assumed greater importance in Indiarecently on account of increasing openness of the economy and the progressive economic andfinancial sector reforms.

Conflicts:The need for simultaneous achievement of several objectives brings in the possibility of conflictamong the different monetary policy objectives. For example, there is often a conflict between theobjectives of holding down both inflation and unemployment; a policy targeted at controllinginflation is very likely to generate unemployment.

As such, based on the set national priorities, the monetary policymakers have to exerciseappropriate trade-offs to balance the conflicting objectives.

SIMILAR QUESTION:1. What are the objectives of monetary policy in India?



Q.No.33. What are the explicit objectives of monetary policy of a developing economy? (B)

According to the needs of developing countries, the explicit objectives of monetary policy are:

a) Maintenance the economic growth,

b) Ensuring an adequate flow of credit to the productive sectors,

c) Sustaining a moderate structure of interest rates to encourage investments, and

d) Creation of an efficient market for government securities.

Q.No.34. State Monetary Transmission Mechanism and its forms? (A)

Monetary Transmission Mechanism: The process or channels through which the change ofmonetary aggregates affects the level of product and prices are known as ‘monetary transmissionmechanism’.

i) It describes how policy-induced changes in the nominal money stock or in the short- termnominal interest rates impact real variables such as aggregate output and employment.

ii) Though monetary policy influence output and inflation, it is not certain about how exactly itdoes so, because the effects of such policy are visible often after a time lag which is notcompletely predictable.

iii) The four different mechanisms through which monetary policy influences the price level andthe national income are:

a) The interest rate channel

b) The exchange rate channel,

c) The quantum channel (e.g., relating to money supply and credit), and

d) The asset price channel i.e. via equity and real estate prices.

SIMILAR QUESTIONS:1. Illustrate the analytics of monetary policy2. Define ‘monetary transmission mechanism’.A. Refer the definition

Q.No.35. Explain the traditional Keynesian interest rate channel of monetary transmissionmechanisms. (B)

Traditional Keynesian Interest Rate Channel: According to the traditional Keynesian interest rate channel,

a) A contractionary monetary policy-induced increase in interest rates increases the cost of capitaland the real cost of borrowing for firms with the result that they cut back on their investmentexpenditures.

When households face higher real borrowing costs they cut back on their purchases of homes,automobiles, and all types of durable goods. A decline in aggregate demand results in a fall inaggregate output and employment.

b) An expansionary monetary policy induced decrease in interest rates decreases the cost of capitalfor firms and cost of borrowing for households.

SIMILAR QUESTION:1. Explain the transmission of monetary policy outcomes through interest rate

channel?



Q.No.36. Explain the exchange rate channel of monetary transmission mechanisms. (B)

In open economies, additional real effects of a policy-induced change in the short term interest ratecome about through the exchange rate channel.

Exchange Rate Channel:The exchange rate channel works through expenditure switching between domestic and foreigngoods.

Appreciation of the domestic currency makes domestically produced goods more expensivecompared to foreign-produced goods. This causes net exports to fall; correspondingly domesticoutput and employment also fall.

Q.No.37. Explain the Credit channel of monetary transmission mechanisms. (A)

Credit Channel:Credit channel operates by altering access of firms and households to bank credit. The proceduraleffect is as follows

a) Most businsses and people mostly depend on bank for borrowing money.

b) “An open market operation” leads first to a contraction in the supply of bank reserves andthen to a contraction in bank credit requires banks to cut back on their lending.

c) This makes the firms that are especially dependent on banks loans to cut back on theirinvestment spending.

d) Thus, there is decline in the aggregate output and employment following a monetarycontraction.

Q.No.38. Explain the Balance sheet channel of monetary transmission mechanisms. (B)

Balance Sheet Channel:As a firm’s cost of credit rises, the strength of its balance sheet deteriorates.

a) A direct effect of monetary policy on the firm’s balance sheet comes through an increase ininterest rates leading to an increase in the payments that the firm must make to repay its floatingrate debts.

b) An indirect effect occurs when the same increase in interest rates works to reduce the capitalizedvalue of the firm’s long-lived assets.

c) Hence, a policy-induced increase in the short-term interest rate not only acts immediately todepress spending through the traditional interest rate channel, it also acts, possibly with a time-lag, to raise each firm’s cost of capital through the balance sheet channel.

d) These together aggravate the decline in output and employment.

Q.No.39. Explain the standard asset price channel of monetary transmission mechanisms. (C)

Standard asset price channel:The standard asset price channel suggests that asset prices respond to monetary policy changes andconsequently affect output, employment and inflation.

a) A policy induced increase in the short-term nominal interest rates makes debt instruments moreattractive than equities in the eyes of investors leading to a fall in equity prices.


No.1 for CA/CWA & MEC/CEC MASTER MINDSb) If stock prices fall after a monetary tightening, it leads to reduction in household financial wealth,

leading to fall in consumption, output, and employment.

SIMILAR QUESTION:1. How do asset prices respond to monetary policy?

Q.No.40. How the different channels functions in an economy in terms of monetarytransmission mechanisms? (C)

The manner in which different channels function in a given economy depends on:

1. The stage of development of the economy, and

2. The underlying financial structure of the economy

Q.No.41. Narrate the operating framework i n implementation of monetary policy? (B)

The operating framework relates to all aspects of implementation of monetary policy. Itprimarily involves three major aspects, namely,

1. Choosing the operating target: The operating target refers to the variable (for e.g. inflation)that monetary policy can influence with its actions

2. Choosing the intermediate target: The intermediate target (e.g. economic stability) is a variablewhich the central bank can hope to influence to a reasonable degree through the operating target andwhich displays a predictable and stable relationship with the goal variables.

3. Choosing the policy instruments: The monetary policy instruments are the various toolsthat a central bank can use to influence money market and credit conditions and pursue itsmonetary policy objectives

SIMILAR QUESTION:1. What is meant by the term ‘monetary policy instruments’?A. Refer 3rd point

Q.No.42. Explain the role of instruments of operating procedure i n implementation ofmonetary policy? (A)

Operating ProceduresThe day-to-day implementation of monetary policy by central banks through variousinstruments is referred to as ‘operating procedures’.

For implementing monetary policy, a central bank can act directly by using its regulatory powers orindirectly by using its influence on money market conditions as the issuer of reserve money(currency in circulation and deposit balances with the central bank).

a) In general, the direct instruments comprise of:i) The required CRRs and SLRs prescribed from time to time.

ii) Directed credit which takes the form of prescribed targets for allocation of credit topreferred sectors (for e.g. Credit to priority sectors), and

iii) Administered i n t e r e s t rates where in the deposit and lending rates are prescribed by thecentral bank.

b) The indirect instruments mainly consist of:i) Repos



ii) Open market operations

iii) Standing facilities, and

iv) Market-based discount window.

SIMILAR QUESTIONS:1. Explain the operating procedures and instruments of monetary policy.2. What is the distinction between direct and indirect instruments of monetary policy?A. Refer a) and b)

3. Define Operating ProceduresA. Refer the definition

Q.No.43. Define Cash Reserve Ratio. (A)

Cash Reserve Ratio (CRR)CRR refers to the fraction of the total net demand and time liabilities (NDTL) of a scheduledcommercial bank in India which it should maintain as cash deposit with the RBI. The CRR has tobe maintained by banks as cash with the RBI

i) The RBI may set the ratio in keeping with the broad objective of maintaining monetarystability in the economy. This requirement applies uniformly to all scheduled banks in thecountry irrespective of its size or financial position.

ii) Non-Bank Financial Institution (NBFIs) are outside the purview of CRR.

iii) The RBI does not pay any interest on the CRR balances maintained by the scheduledcommercial banks (SCBs) with effect from the fortnight beginning March 31, 2007.

iv) The failure of a bank to meet its required reserve requirements would attract penalty in theform of penal interest charged by the RBI.

v) The CRR as on 8th July, 2017 was 4 %

CRR acts as an important quantitative tool aiding in liquidity managementi) CRR in recent years stood as an important quantitative tools aiding in liquidity management.

Higher the CRR with the RBI, lower will be the liquidity in the system and vice versa.

ii) During slowdown in the economy, the RBI reduces the CRR in order to enable the banks toexpand credit and increases the supply of money available in the economy.

iii) In order to control credit expansion during periods of high inflation, the RBI increases theCRR.

SIMILAR QUESTION:1. Write notes on Cash Reserve Ratio (CRR) Explain the operation of CRR

Q.No.44. Define Statutory Liquidity Ratio (SLR). (A)

Statutory Liquidity Ratio (SLR)As per the Banking Regulations Act 1949, all scheduled commercial banks in India arerequired to maintain a stipulated percentage of their total Demand and Time Liabilities (DTL) / NetDTL (NDTL) in one of the following forms:

1. Cash

2. Gold, or

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No.1 for CA/CWA & MEC/CEC MASTER MINDS3. Investments in un-encumbered Instruments

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 a penal interest payable to RBI.

As per the Second Bi-Monthly Monetary Policy Statement 2017-18 of the RBI on June 7th2017, it has been decided to reduce the SLR from 20.5% to 20% from June 24, 2017.

Investments in un-encumbered Instruments includes: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 (i.e. securities issued by PSEs).SIMILAR QUESTION:1. What are the eligible securities for SLR?A. Refer from introduction to 3rd point

Q.No.45. How the SLR functions as a powerful tool for controlling liquidity in an economy? (A)

The SLR is also a powerful tool for controlling liquidity in the domestic market by means ofmanipulating bank credit.

a) Changes in the SLR influence the availability of resources in the banking system for lending.

b) A rise in the SLR during periods of high liquidity, tends to lock up a rising fraction of a bank’sassets in the form of eligible instruments. This reduces the credit creation capacity of banks.

c) A reduction in the SLR during periods of economic downturn has the opposite effect.

d) The SLR requirement also facilitates a captive market for government securities.

SIMILAR QUESTION:1. Explain the functioning of SLR?

Q.No.46. Explain about Liquidity Adjustment Facility (LAF). (A)

Liquidity Adjustment Facility (LAF):From June 2000, the RBI has introduced Liquidity Adjustment Facility (LAF).1. The LAF is a facility extended by the RBI to the scheduled commercial banks (excluding RRBs)

and primary dealers to avail of liquidity in case of requirement (or park excess funds with theRBI in case of excess liquidity) on an overnight basis against the collateral ofgovernment securities including state government securities.

2. The introduction of LAF is an important landmark since it triggered a rapid transformation in themonetary policy operating environment in India.

3. As a key element in the operating framework of the RBI, its objective is to assist banks to adjusttheir day to day mismatches in liquidity.

4. Currently, the RBI provides financial accommodation to the commercial banks throughrepos/reverse repos under the LAF.

SIMILAR QUESTION:1. What is the role of Liquidity Adjustment Facility (LAF)?



Q.No.47. Define Repo and name the types of repo markets operating in India. (A)

Repo: Repurchase Options or in short ‘Repo’, is defined as ‘an instrument for borrowing fundsby selling securities with an agreement to repurchase the securities on a mutually agreedfuture date at an agreed price which includes interest for the funds borrowed’.

a) Repo is a money market instrument, which enables collateralised short term borrowing andlending through sale/purchase operations in debt instruments.

b) The Repo transaction in India has two elements: - i) the seller sells securities and receivescash while the purchaser buys securities and parts with cash. ii) the securities are repurchasedby the original holder.

c) The user pays to the counter party the amount originally received, plus the return on themoney for the number of days for which the money was used, which is mutually agreed.

d) All these transactions are reported on the electronic platform called the Negotiated DealingSystem (NDS).

e) The Clearing Corporation of India Ltd. (CCIL) has put in an anonymous online repo dealingsystem in India, with an anonymous order matching electronic platform.

f) Repo or repurchase option is a collaterised lending.

g) The rate charged by RBI for this transaction is called the ‘repo rate’.

h) Repo operations thus inject liquidity into the system.

There are three types of repo markets operating in India namely:

1. Repo on sovereign securities

2. Repo on corporate debt securities

3. Other Repos

SIMILAR QUESTION:

1. Define ‘repo’

A. Refer the definition

Q.No.48. Define Reverse Repo. (A)

Reverse Repo:‘Reverse Repo’ is defined as an instrument for lending funds by purchasing securities with anagreement to resell the securities on a mutually agreed future date at an agreed price whichincludes interest for the funds lent .

a) Reverse repo operation takes place when RBI borrows money from banks by giving themsecurities.

b) The securities transacted here can be either government securities or corporate securities or anyother securities which the RBI permits for transaction.

c) The interest rate paid by RBI for such transactions is called the ‘reverse repo rate’.

d) Reverse repo operation in effect absorbs the liquidity in the system.

e) The collaterals used for repo and reverse repo operations consist of primarily Government ofIndia securities i.e. all SLR-eligible transferable Government of India dated securities/treasurybills.

f) From May, 2011 onwards, the reverse repo rate is not announced separately, it will be linked torepo rate.


No.1 for CA/CWA & MEC/CEC MASTER MINDSConclusion: The ‘repo rate’ and the reverse repo rate’ are changed only through the announcementsmade during the Monetary Policy Statements of the RBI. The RBI also conducts variable interest ratereverse repo auctions, as necessitated under the market conditions.

SIMILAR QUESTION:1. Define ‘Reverse Repo’.

A. Refer the definition

Q.No.49. Define the policy rate (B)

Policy Rate:In India, the fixed repo rate quoted for sovereign securities in the overnight segment of LiquidityAdjustment Facility (LAF) is considered as the policy rate. (It may be noted that India hasmany other repo rates in operation).

a) The RBI uses the single independent ‘policy rate’ which is the repo rate (in the LAF window) forbalancing liquidity.

b) The policy rate is in fact, the key lending rate of the central bank in a country.c) A change in the policy rate gets transmitted through the money market to the entire financial

system and alters all other short term interest rates in the economy, by influencingaggregate demand – a key determinant of the level of inflation and economic growth.

d) If the RBI wants to make it more expensive for banks to borrow money, it increases the repo rateand vice-versa

e) An increase in the repo rate will lead to liquidity tightening and vice-versa, other things remainingconstant.

SIMILAR QUESTION:1. What is meant by ‘policy rate’?A. Refer the definition

Q.No.50. Explain Marginal Standing Facility (MSF). (A)

The Reserve Bank of India, being a bankers’ bank, acts as a lender of last resort.

Marginal Standing Facility (MSF):The MSF announced by the RBI in its Monetary Policy, 2011-12.

It refers to the facility under which scheduled commercial banks can borrow additional amount ofovernight money from the central bank over and above what is available to them through the LAFwindow by dipping into their SLR portfolio up to a limit ( a fixed per cent of their net demand and timeliabilities deposits (NDTL) liable to change every year ) at a penal rate of interest.

a) This provides a safety valve against unexpected liquidity shocks to the banking system.

b) The scheme has been introduced by RBI with the main aim of reducing volatility in the overnightlending rates in the inter-bank market and to enable smooth monetary transmission in thefinancial system.

c) Banks can borrow through MSF on all working days except Saturdays, between 7.00 pm and 7.30pm, in Mumbai. The minimum amount which can be accessed through MSF is Rs.1 crore andmore will be available in multiples of Rs.1 crore.

d) The MSF would be the last resort for banks once they exhaust all borrowing options including theLAF on which the rates are lower compared to the MSF.

e) The MSF rate being a penal rate automatically gets adjusted to a fixed per cent above the repo rate.

f) MSF is at present aligned with the Bank rate.



g) Practically, MSF represents the upper band of the interest corridor with repo rate at themiddle and reverse repo at the lower band.

h) In fact, the MSF rate and reverse repo rate determine the corridor for the daily movement inthe weighted average call money rate.

Q.No.51. What are the recent amendments of monetary policy in India? (A)

1. In addition to the existing overnight LAF (repo and reverse repo) and MSF, from October 2013,the Reserve Bank has introduced ‘Term Repo’ (repos of duration more than a day) under theLiquidity Adjustment Facility (LAF) for 14 days and 7 days tenors. LAF is conducted at a fixedtime on a daily basis on all working days in Mumbai (excluding Saturdays).

2. As per the Second Bi-Monthly Monetary Policy Statement 2017-18 of the RBI on June 7th 2017, theMonetary Policy committee (MPC) has decided to keep the policy repo rate under the LAF unchangedat 6.25 %, the reserve repo rate at 6.00 % and the MSF rate and the Bank rate at 6.50 %.

Q.No.52. Define Market Stabilisation Scheme. (B)

Market Stabilisation Scheme (MSS)MSS for monetary management was introduced in 2004 following a MoU between the RBI and theGovernment of India (GoI) with the primary aim of aiding the sterilization operations of the RBI.

Under this scheme, the GoI borrows from the RBI (additional to its normal borrowing requirements)and issues treasury-bills/dated securities for absorbing excess liquidity from the market arising fromlarge capital inflows.

Note: Sterilization is the process by which the monetary authority sterilizes the effects of significantforeign capital inflows on domestic liquidity by off-loading parts of the stock of government securitiesheld by it.

Similar Questions1. What role does Market Stabilisation Scheme (MSS) play in our economy?2. Define Sterilisation.A. Refer note

Q.No.53. Define Bank Rate and its applicability. (A)

Bank Rate:Under Section 49 of the Reserve Bank of India Act, 1934, the Bank Rate has been defined as ‘thestandard rate at which the RBI is prepared to buy or re- discount bills of exchange or othercommercial paper eligible for purchase under the Act’.

Introduction and applicability of Bank rate in India:a) The bank rate once used to be the policy rate in India i.e. the key interest rate based on which

all other short term interest rates moved.

b) Discounting/rediscounting of bills of exchange by the Reserve Bank has been discontinued onintroduction of Liquidity Adjustment Facility (LAF).

c) As a result, the bank rate has become dormant as an instrument of monetary management.

d) The bank rate has been aligned to the Marginal Standing Facility (MSF) rate and, as and whenthe MSF rate changes alongside policy, the repo rate changes, the bank rate also changesautomatically.


No.1 for CA/CWA & MEC/CEC MASTER MINDSe) MSF assumed the role of bank rate and currently the bank rate is purely a signalling rate and

most interest rates are delinked from the bank rate.

f) Now, bank rate is used only for calculating penalty on default in the maintenance of CashReserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR).

SIMILAR QUESTION:1. Assess the role of Bank Rate as an instrument of monetary policy

Q.No.54. Explain the concept of Open Market Operations. (B)

Open Market Operations (OMO): OMO is defined as market operations conducted by the RBI byway of sale/ purchase of Government securities to/ from the market with an objective to adjust therupee liquidity conditions in the market on a durable basis.

a) When the RBI feels there is excess liquidity in the market, it resorts to sale of securities therebysucking out the rupee liquidity.

b) When the liquidity conditions are tight, the RBI will buy securities from the market, therebyreleasing liquidity into the market.

Q.No.55. State the organisational structure for monetary policy decisions? (A)

The organisational structure of monetary policy decisions is necessary to understand the way inwhich monetary policy is conducted in India.The Reserve Bank of India Act, 1934 was amended on June 27, 2016, for giving a statutorybacking to the Monetary Policy Framework Agreement and for setting up a Monetary PolicyCommittee (MPC).

Q.No.56. Explain the Monetary Policy Framework Agreement (B)

The Monetary Policy Framework Agreement:The Reserve Bank of India Act, 1934 was amended on June 27, 2016, for giving a statutorybacking to the Monetary Policy Framework Agreement.

It is an agreement reached between the GoI and the RBI on the maximum tolerable inflation ratethat the RBI should target to achieve price stability.

a) The amended RBI Act (2016) provides for a statutory basis for the implementation ofthe ‘flexible inflation targeting framework’.

b) Announcement of an official target range for inflation is known as inflation targeting.

c) The Expert Committee under Urijit Patel to revise the monetary policy framework, in its reportin January, 2014 suggested that RBI abandon the ‘multiple indicator’ approach and makeinflation targeting the primary objective of its monetary policy.

d) The inflation target is to be set by the GoI, in consultation with the RBI, once in every fiveyears.

e) Accordingly, the Central Government has notified 4 % Consumer Price Index (CPI) inflation asthe target for the period from August 5, 2016 to March 31, 2021 with the upper tolerancelimit of 6 % and the lower tolerance limit of 2 %.

f) The RBI is mandated to publish a Monetary Policy Report every 6 months, explaining thesources of inflation and the forecasts of inflation for the coming period of 6 to 18 months.

g) The following factors are notified by the central government as constituting a failure to achievethe inflation target:



i) The average inflation is more than the upper tolerance level of the inflation target for anythree consecutive quarters; or

ii) The average inflation is less than the lower tolerance level for any three consecutivequarters.

Note: The choice of CPI was made because it closely reflects cost of living and has largerinfluence on inflation expectations compared to other anchors. With this step, India is followingcountries such as the New Zealand, the USA, the UK, European Union, and Brazil. In recent timesmany countries are moving away from this approach and the targeting nominal GDP growth.

SIMILAR QUESTION:1. Describe the organizational structure for monetary policy decisions in India

Q.NO.57. What is the role of the Monetary Policy Committee (MPC) in Indian monetary policy?(B)

The Reserve Bank of India Act, 1934 was amended on June 27, 2016, for setting up a MonetaryPolicy Committee (MPC).

An important landmark in India’s monetary history is the constitution of an empowered six-memberMonetary Policy Committee (MPC) in September, 2016.a ) MPC consists of

i) The RBI Governor (Chairperson),ii) The RBI Deputy Governor in charge of monetary policy,iii) One official nominated by the RBI Board andiv) the remaining three central government nominees representing the Government of India whoare persons of ability, integrity and standing, having knowledge and experience in the field ofEconomics or banking or finance or monetary policy.

b) The MPC shall determine the policy rate required to achieve the inflation target.c) The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the

monetary policy.d) The views of key stakeholders in the economy and analytical work of the Reserve Bank

contribute to the process for arriving at the decision on the policy repo rate.e) Accordingly, fixing of the benchmark policy interest rate (repo rate) is made through

debate and majority vote by this panel of experts.f) With the introduction of the MPC, the RBI will follow a system which is more consultative and

participative similar to the one followed by many of the central banks in the world.g) The new system is intended to incorporate:

i) Diversity of views,ii) Specialized experience,iii) Independence of opinion ,iv) Representativeness, andv) Accountability.

h) The Financial Markets Operations Department (FMOD) operationalises the monetarypolicy, mainly through day-to-day liquidity management operations. The Financial MarketsCommittee (FMC) meets daily to review the liquidity conditions so as to ensure that the operatingtarget of monetary policy (weighted average lending rate) is kept close to the policy repo rate.

SIMILAR QUESTION:1. Outline the role of Monetary Policy Committee (MPC)



Q.NO.58. What is the role of Technical Advisory Committee (TAC) before the constitution ofMonetary Policy Committee (MPC)? (C)

Before the constitution of the MPC, a Technical Advisory Committee (TAC) on monetary policy withexperts from Monetary Economics, Central Banking, Financial Markets and Public Finance advisedthe RBI on the standpoint of monetary policy. However, its role was only advisory in nature. With theformation of MPC, the TAC on Monetary Policy ceased to exist.

Q.No.59. What is an obvious advantage of money having a single unit of account? (C)

An obvious advantage of having a single unit of account is that it greatly reduces the number ofexchange ratios between goods and services.

Q.No.60. “It is convenient to trade all commodities in exchange for a single commodity i.e. interms of money.” Comment on it. (C)

It is convenient to measure the prices of all commodities in terms of a single unit, rather than recordthe relative price of every good in terms of every other good. Use of money as a unit of account canencourage trade by making it easier for individuals to know how much one good is worth in terms ofanother.

Q.No.61. The splitting of purchases and sale into two transactions involves a separation inboth time and space. How this separation is possible? (C)

This separation is possible because money can be used as a store of value or store of means ofpayment during the intervening time.

Q.No.62. “All assets other than money lack perfect reversibility.” Support the sentence. (C)

All assets other than money lack perfect reversibility in the sense that their value in payment is notequal to their value in receipt.

Q.No.63. Despite having the advantages of potential income yield and appreciation in valueover time, name the assets which are subject to limitations such as storage costs, lack ofliquidity and possibility of depreciation in value. (C)

Government bonds, deposits and other securities, land, houses etc.

Q.No.64. Even financial assets like the riskless government bonds do not command perfectreversibility. Why? (C)

As the purchase and sale of financial assets are subject to certain brokerage costs although this maybe quite small they do not command perfect reversibility.

QUESTIONS FOR ACADEMIC INTEREST – FOR STUDENT SELF STUDY

Copyrights Reserved




Q.No.65. How the role of money in the macro economy is usually examined? (C)

The role of money in the macro economy is usually examined in a supply/demand framework.

Q.No.66. If a person hold his wealth in the form of interest yielding asset other than moneywhat will be the opportunity cost of holding money? (C)

The opportunity cost of holding money is the interest rate a person could earn on other assets.

Q.No.67. Name the versions which are chiefly concerned with money as a means oftransactions or exchange, and represents models of the transaction demand for money? (C)

The versions are of Irving Fisher (classical approach) and Cambridge approach (Neo-classicalapproach) represents models of the transaction demand for money.

Q.No.68. According to Speculative demand for money by Keynes the market value of bondsand the market rate of interest are inversely related. Explain the sentence. (C)

Keynes the market value of bonds and the market rate of interest are inversely related.1. If wealth-holders consider that the current rate of interest is high compared to the ‘normal or

critical rate of interest’, they expect a fall in the interest rate (rise in bond prices). At the highcurrent rate of interest, they will convert their cash balances into bonds because:

a) They can earn high rate of return on bonds

b) They expect capital gains resulting from a rise in bond prices consequent upon an expectedfall in the market rate of interest in future.

2. If the wealth-holders consider the current interest rate as low, compared to the ‘normal orcritical rate of interest’, i.e., if they expect the rate of interest to rise in future (fall in bond prices),they would have an incentive to hold their wealth in the form of liquid cash rather than bondsbecause:a) The loss suffered by way of interest income forgone is small,b) They can avoid the capital losses that would result from the anticipated increase in interest rates,

andc) The return on money balances will be greater than the return on alternative assets

3. If the interest rate does increase in future, the bond prices will fall and the idle cash balances heldcan be used to buy bonds at lower price and can thereby make a capital-gain.

Q.No.69. What is meant by carrying cost in the words of Baumol’s theory? (C)

Carrying cost is the interest forgone by holding money and not bonds. It is the net of the cost to theindividual of making a transfer between money and bonds, say for example brokerage fee.

Q.No.70. Name the different approaches of demand for money and their purpose. (C)

Approach of Demand for money ObjectiveTransaction version of Fisher Focus on supply of money as determining pricesThe cash balance approach of theCambridge University

Established the formal relationship between demand for realmoney and the real income.



Demand for money by Keynes on the basis of explicit motives for holding money and formallyintroduced the interest rate as an additional explanatoryvariable that determines the demand for real balances.

Post-Keynesian economists developed a number of models to provide alternativeexplanations to confirm the formulation relating real moneybalances with real income and interest rates.

Q.No.71. In general what will be the relation of demand for money with real income andinterest rate? (C)

All the theories of demand for money establish a positive relation of demand for money to real incomeand an inverse relation to the rate of return on earning assets, i.e. the interest rate.

Q.No.72. Name the significant predictors of demand for money. (C)

Real income, interest rates and expectations in respect to inflation are significant predictors ofdemand for money.

Q.No.73. Define the following terms. (C)

Reserve ratio: The ratio of cash reserves of commercial banks to deposits known as the ‘reserve ratio’.

Currency-deposit ratio (c): The currency-deposit ratio (c) represents the degree of adoption ofbanking habits by the people.

Time Deposit - Demand Deposit Ratio: The time deposit - demand deposit ratio representshow much money is kept as time deposits compared to demand deposits,

Q.No.74. Briefly summarise the money multiplier approach. (C)

1. The size of the money multiplier is determined by:

a) The required reserve ratio (r) at the central bank,

b) The excess reserve ratio (e) of commercial banks and

c) The currency ratio (c) of the public

2. The lower these ratios, the larger will be the money multiplier.

3. The money supply is determined by high powered money (H) and the money multiplier (m) and variesdirectly with changes in the monetary base, and inversely with the currency and reserve ratios.

4. Although these three variables do not completely explain changes in the nominal money supply,nevertheless they serve as useful devices for analysing such changes.

5. Consequently, these variables are designated as the ‘proximate determinants’ of the nominalmoney supply in the economy.

Q.No.75. What are the additional complexities arise in terms of monetary policy in aemerging market like India. (C)

There are many challenges which need to be addressed, such as rudimentary and noncompetitivefinancial systems, lack of integrated money and interbank markets, external uncertainties and issuesrelated to operational autonomy of the central bank.



Q.No.76. What does an explicit inflation targeting requires in a monetary policy? (C)

Explicit inflation targeting requires a good degree of operational autonomy for the central bank and asystem in which there is a good coordination between fiscal and monetary authorities.

Q.No.77. Why there are differences among different countries in respect of theselection of objectives, implementation procedures and tools of monetary policy? (C)

The differences among the countries in selection of monetary policy may be either due to differencesin the underlying economies or due to differences in the financial systems and in the infrastructure offinancial markets.

Q.No.78. What were the objectives of monetary policy in the past? (C)

Period Objectives of monetary policyPre-Keynesian period Establishment and maintenance of stability in prices.The Great Depression in 1930s and theassociated economic crises

Maintenance of full employment, more generallydescribed as economic stability.

Q.No.79. What are the most commonly pursued objectives of monetary policy of the centralbanks across the world? (C)

They are

1. Maintenance of price stability (or controlling inflation)

2. Achievement of high level of economy’s growth

3. Maintenance of full employment

Q.No.80. Why the Reserve Bank of India Act, 1934 sets out the objectives of the Bank? (C)

RBI sets the objectives in its preamble

1. To regulate the issue of bank notes

2. keeping of reserves with a view to securing monetary stability in India

3. To operate the currency and credit system of the country to its advantage.

Q.No.81. What are the two distinct credit channels also allow the effects of monetarypolicy actions to spread through the real economy? (C)

Two distinct credit channels- the bank lending channel and the balance sheet channel- also allowthe effects of monetary policy actions to spread through the real economy.

Q.No.82. Explain Credit Multiplier with an example. (C)

The credit multiplier is the reciprocal of the required reserve ratio.

RatioReserveRequired1multiplierCredit Copyrights Reserved



No.1 for CA/CWA & MEC/CEC MASTER MINDSThe credit multiplier explains that when a bank uses the deposited money for lending, the bankgenerates another claim on a given amount of deposited money.

For example, If A deposits Rs. 1000/ in cash at a bank (Bank X), this constitutes the bank's currenttotal cash deposits. The Proceeds are as follows:

a) If the required reserve is 10 percent, the bank would lend Rs.900/ to B.

b) By lending B Rs. 900/, the bank creates a deposit for Rs. 900/ that B can now use. It is asthough B owns Rs.900/. This in turn means that A will continue to have a claim againstRs.1000/ while B will have a claim against Rs.900/.

c) The bank has Rs.1000/ in cash against claims of Rs.1900/. In short, the bank has createdRs.900/ out of "thin air" since these Rs.900/ are not supported by any genuine money.

d) At any time, the fractional reserve commercial banks have more cash liabilities than cash intheir vaults.

e) Now suppose B buys goods worth Rs.900/ from C and pays C by cheque. C places thecheque with his bank, Bank Y.

f) After clearing the cheque, Bank Y will have an increase in cash of Rs.900/, which it may takeadvantage of and use to lend out Rs.810/ to D which may again be deposited in anotherbank, say Bank Z.

g ) Again 10 per cent of Rs.810 (Rs.81) has to be kept as required reserves and the remainingRs.719/ can be lent out, say to E.

h ) This sequence keeps on continuing until the initial deposit amount Rs.1,000 grows exactly bythe multiple of required reserves(in this case, 10%).

i) Ultimately, the expanded credit availability would be 1000 + 900 (90% of 1000) + 810 (90%of 900) + 729 (90% of 810) + (90% of 719) +… …. This summation would end with an amountwhich is equivalent to 1/10% of 1000, which is Rs.10,000.

j) Thus, in our example, the initial deposit is capable of multiplying itself out 10 times.

In short, we find that the fact that banks make use of demand deposits for lending it sets inmotion a series of activities leading to expansion of money that is not backed by money proper.

SIMILAR QUESTION:1. Define credit multiplier. How is it calculated?

1. Describe the various theories related to demand for money.

2. Explain why bond prices move inversely to market interest rates.

3. Name the post Keynesian theories of demand for money.

4. Why should you hold money balances?

5. Will you choose to hold only interest bearing assets?

6. What would your choice be if you can pay for nearly all transactions through onlinetransfers?

7. Do you think money is a unique store of value?

8. Distinguish between the different variables considered by each of the theories of demand formoney.

9. Describe with illustrations how changes in high powered money, required reserves, excessreserves and currency ratio, influence the money supply in an economy?

TEST YOUR KNOWLEDGE



10. What would be the effect on money multiplier if banks hold excess reserves?

11. What effect does government expenditure have on money supply?

12. What is the value of the money multiplier in a system of 100% reserve banking?

13. Name the different determinants of money supply in a country.

14. Prepare separate graphs using excel on ‘Money Stock: Components and Sources’ and ‘ReserveMoney: Components and Sources’ for four previous months from the weekly statisticalsupplements published by Reserve Bank of India. Identify the trends in each.

15. Compute Reserve Money from the following data published by RBI Components(In billions of Rs.) As on 7 July 2017.

Currency in Circulation 15428.40Bankers’ Deposits with RBI 4596.18’Other’ Deposits with RBI 183.30

16. Compute M3 from the following data published by RBI

Components (In billions of Rs.)As on 31 March, 2017

Currency with the Public 12637.1Demand Deposits with Banks 14,106.3Time Deposits with Banks 101,489.5‘Other’ Deposits with Reserve Bank 210.9

17. What will be the total credit created by the commercial banking system for an initial depositof Rs.1000/- for required reserve ratio 0.02, 0.05 and 0.10 percent respectively? Computecredit multiplier.

18. How would each of the following affect money multiplier and money supply?

a) Commercial banks in India decide to hold more excess reserves

b) Fearing shortage of money in ATMs, people decide to hoard money

c) Banks open large number ATMs all over the country

d) E banking becomes very common and nearly all people use them

e) During festival season , people decide to use ATMs very often

f) If banks decide to keep 100% reserves. What would be the effect on money multiplier andmoney supply?

g) Suppose banks need to keep no reserves only 0% reserves are there.

19. Are there any standards across the world to measure money supply?

20. In India by whom the range of monetary and liquidity measures are compiled and published?

21. What is the effect of money constituents on money supply?

22. What is the cost of holding excess reserves is in terms of its opportunity cost?

23. What would be the behaviour of money supply when depositors decide to increase currencyholding, with all other variables unchanged?

24. Fundamentally, what is the primary objective of monetary policy?

25. How the monetary policy can influence overall economic performance?

26. Open Market Operations

27. Make a critical evaluation of the latest monetary policy statement of the Reserve Bank of India.


No.1 for CA/CWA & MEC/CEC MASTER MINDS28. What will be the nature of the monetary policy undertaken by RBI in the following?

a) Increases repo rate by 50 basis points

b) Reduces the cash reserve ratio

c) Increases the supply of currency and coins

d) Terminates marginal standing facility

e) Increases the interest rates chargeable by commercial banks

f) Sells securities in the open market

g) Initiates reverse repo operation

h) Changes in the SLR

29. Write a brief note about the reasons why the policy rates were changed /not changed in therecent monetary policy announcement by the RBI

THE END

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