CBSE Class 12 Economics Money And Banking Notes

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Revision Notes for Class 12 Economics Part B Macroeconomics Chapter 3 Money and Banking

Class 12 Economics students should refer to the following concepts and notes for Part B Macroeconomics Chapter 3 Money and Banking in Class 12. These exam notes for Class 12 Economics will be very useful for upcoming class tests and examinations and help you to score good marks

Part B Macroeconomics Chapter 3 Money and Banking Notes Class 12 Economics

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MEANING OF MONEY: Money is anything which is generally accepted as medium of exchange, measure of value, store of value and as means of standard of deferred payment.

FUNCTIONS OF MONEY: Functions of money can be classified into Primary and Secondary

Primary/Basic functions:-
i) Medium of Exchange: - It can be used in making payments for all transactions of goods and services.

ii) Measure /Unit of value: - It helps in measuring the value of goods and services. The value is usually called as price. After knowing the value of goods in single unit (price) exchanges become easy.

Secondary functions:-
i) Standard of deferred payments: Deferred payments referred to those payments which are to be made in near future.
Money acts as a standard deferred payment due to the following reasons:
a) Value of money remains more or less constant compared to other commodities.
b) Money has the merit of general acceptability.
c) Money is more durable compare to other commodity

ii) Store of value: Money can be stored and does not lose value Money acts as a store of value due to the following reasons:
a) It is easy and economical to store.
b) Money has the merit of general acceptability.
c) Value of money remains relatively constant

MONEY HAS OVERCOME THE DRAW BACKS OF BARTER SYSTEM:

1. Medium of Exchange: Money has removed the major difficulty of the double coincidence of wants.

2. Measure of value: Money has become measuring rod to measure the value of goods and services and is expressed in terms of price.

3. Store of value: It is very convenient, easy and economical to store the value and has got general acceptability which was lacking in the barter system.

4. Standard of deferred payments: Money has simplified the borrowing and lending of operations which were difficult under barter system. It also encourages capital formation.

MONEY SUPPLY: refers to total volume of money held by public at a particular point of time in an economy.
M1=currency held by public + Demand deposits + other deposits with Reserve Bank of India.
M2=M1+saving deposits with post office saving bank
M3=M1+net time deposit with the bank
M4=M3 + total deposits with post office saving bank excluding national saving certificate

HIGH POWERED MONEY:

Refers to, currency with the public (notes +coins) and cash reserve of banks.

MONEY CREATION/DEPOSIT CREATION/CREDIT CREATION BY COMMERCIAL
BANK
Let us understand the process of credit creation with the following example.
Suppose there is an initial deposit of Rs. 1000 and L.R.R. is 20% i.e., the banks have to keep Rs. 200 and lend Rs. 800/-. All the transactions are routed through banks. The borrower withdraws his Rs. 800/- for making payments which are routed through banks in the form of deposits account. The Bank receives Rs. 800/- as deposit and keeps 20% of Rs.800/- i.e., Rs.160/- and lends Rs.640/- . Again the borrower uses this for payment which flows back into the banks thereby increasing the flow of deposits.

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Money Multiplier = 1/LRR. In the above example LRR is 20% i.e., 0.2, so money multiplier is equal to 1/0.2=5.

Why only a fraction of deposits is kept as Cash Reserve?
a) All depositors do not withdraw the money at the same time.
b) There is constant flow of new deposits into the banks.

CENTRAL BANK
MEANING: An apex body that controls, operates, regulates and directs the entire banking and monetary structure of the country.

FUNCTIONS OF CENTRAL BANK:
i) Currency authority or bank of issue: Central bank is a sole authority to issue currency in the country. Central Bank is obliged to back the currency with assets of equal value (usually gold coins, gold bullions, foreign securities etc.,)

Advantages of sole authority of note issue:
a) Uniformity in note circulation
b) Better supervision and control
c) It is easy to control credit
d) Ensures public faith
e) Stabilization of internal and external value of currency

ii) Banker to the Government:
As a banker it carries out all banking business of the Government and maintains current account for keeping cash balances of the government.
Accepts receipts and makes payments for the government. It also gives loans and Advances to the government.

iii) Banker’s bank and supervisor: Acts as a banker to other banks in the country—
a) Custodian of cash reserves:- Commercial banks must keep a certain proportion of cash reserves with the central bank (CRR)
b) Lender of last resort: - When commercial banks fail to need their financial requirements from other sources, they approach Central Bank which gives loans and advances.
c) Clearing house: - Since the Central Bank holds the cash reserves of commercial banks it is easier and more convenient to act as clearing house of commercial banks.

iv) Controller of money supply and credit: - Central Bank or RBI plays an important role during the times of economic fluctuations. It influences the money supply through quantitative and qualitative instruments. Former refers to the volume of credit and the latter refers to regulate the direction of credit.

v) Custodian of foreign exchange reserves. Another important function of Central Bank is the custodian of foreign exchange reserves. Central Bank acts as custodian of country’s stock of gold and foreign exchange reserves. It helps in stabilizing the external value of money and maintaining favorable balance of payments in the economy.

QUANTITATIVE INSTRUMENTS:

i) Bank Rate policy: - It refers to the rate at which the central bank lends money to commercial banks as a lender of the last resort.
Central Bank increases the bank rate during inflation (excess demand) and reduces the same in times of deflation (deficient demand)

ii) Open Market Operations: It refers to the buying and selling of securities by the Central Bank from/ to the public and commercial banks.
It sells government securities during inflation/excess demand and buys the securities during deflation/deficient demand.

iii) Legal Reserve Ratio: R.B.I. can influence the credit creation power of commercial banks by making changes in CRR and SLR Cash Reserve Ratio (CRR): It refers to the minimum percentage of net demand and time liabilities to be kept by commercial banks with central bank.

Reserve Bank increases CRR during inflation and decreases the same during deflation Statutory Liquidity Ratio (SLR): It refers to minimum percentage of net demand and time liabilities which commercial banks required to maintain with themselves.
SLR is increased during inflation or excess demand and decreased during deflation or deficient demand.

QUALITATIVE INSTRUMENTS:
1. Margin Requirements: It is the difference between the amount of loan and market value of the security offered by the borrower against the loan.
Margin requirements are increased during inflation and decreased during deflation.
2. Moral suasion: It is a combination of persuasion and pressure that Central Bank applies on other banks in order to get them act in a manner in line with its policy
3. Selective credit controls: Central Bank gives direction to other banks to give or not to give credit for certain purposes to particular sectors.

SHORT AND LONG ANSWER QUESTIONS
1. Define Central Bank.
2. Give the meaning of money.
3. Discuss the functions of money.
4. Describe how money over comes the problems of barter system?
5. What are the measures of money supply?
6. What do you mean by High powered money?
7. Describe the process of money creation or credit creation by commercial banks.
8. Why only a fraction of deposits is kept as Cash Reserves?
9. Discuss the functions of Central Bank.
10. Bring out the role of Central Bank as the controller of money supply or credit.
11. Explain the various qualitative and quantitative instruments used by the central bank in controlling the money supply during the times of
a) excess demand/inflation
b) deficient 
demand/deflation.

HOTS

Question. Calculate the value money multiplier and the total deposit created if initial deposit is of Rs. 500 crores and LRR is 10%.
Answer : Money multiplier = 1/LRR which is equal to 1/0.1=10
Initial deposit Rs. 500 crores
Total deposit = Initial deposit x money multiplier
= 500 x 10 = 5000 crores.

Question. If total deposits created by commercial banks are Rs.12000, LRR is 25% calculate initial deposit.
Answer : Money multiplier = 1/LRR = 1/.25 = 4
Initial deposit = Total deposit / money multiplier = 12000/4 = 3000

Question. Calculate LRR, if initial deposit of Rs. 200 cores lead to creation of total deposits of Rs. 1600 cores.
Answer : Money multiplier = Total deposits/Initial deposits = 1600/200=8
Money multiplier = 1/LRR = 8=1/LRR.
LRR = 1.25 or 12.5

More Questions..........

Question. Two components of money supply are _____ and _____. 
Answer : (i) Currency held with public 
          (ii) Demand deposits of the public with commercial banks. 

Question. Supply of money refers to _________.
(a) currency held by the public 
(b) currency held by Reserve Bank of India (RBI) 
(c) currency held by the public and demand deposits of the public with commercial banks 
(d) currency held in the government account 
Answer : C
  
Question. Demand deposits include _______. 
(a) Saving account deposits and fixed deposits 
(b) Saving account deposits and current account deposits 
(c) Current account deposits and fixed deposits 
(d) All types of deposits
Answer : B
 
Question. Deposit creation by banks comes to an end when _____. 
(a) fresh deposits with banks become zero 
(b) legal reserve ratio becomes zero 
(c) money multiplier becomes zero 
(d) total reserves equal initial deposits
Answer : D
 
Question. The ratio of net total deposits that a commercial bank has to keep with Reserve Bank of India is called: 
(a) Statutory liquidity ratio 
(b) Deposit ratio 
(c) Cash reserve ratio 
(d) Legal reserve ratio 
Answer : C
 
Question. Which of the following is not a Quantitative Method of credit control? 
(a) Open Market Operation 
(b) Margin Requirements 
(c) Variable Reserve Ratio 
(d) Bank Rate Policy
Answer : B
 
Question. Who regulates money supply? 
Ans.(a) Government of India 
(b) Reserve Bank of India 
(c) Commercial Banks 
(d) Planning Commission 
Answer : B
 
Question. Total deposits created by commercial banks is `12,000 croreand LRR is 25%. Calculate the amount of initial deposits. 
(a) `6000 crore 
(b) `4000 crore 
(c) `5000 crore 
(d) `3000 crore 
Answer : D
 
Question. __________ is the main source of money in an economy. 
(a) Central bank 
(b) Commercial banks 
(c) Both (a) and (b) 
(d) Government 
Answer : (c) Both (a) and (b)
 
Question. If Reserve Deposit Ratio is 12.5%, the value of money multiplier will be:
(a) 2
(b) 5
(c) 8
(d) 10 
Answer : C
 
Question. The formula used for calculating money multiplier : 
(a) 1/Cash Reserve Ratio 
(b) 1/Statutory Liquidity Ratio 
(c) 1/Legal Reserve Ratio 
(d) All of the above 
Answer : C
 
Question. Repo rate relates to ________. 
(a) Short-term borrowings by commercial banks 
(b) Long-term borrowing by commercial banks 
(c) Disinvestments 
(d) Dis-savings
Answer : A
 
Question. State whether the following statement is true or false: Currency created by the Central Bank is called bank money. 
Answer : False: The currency created by the Central bank (Reserve Bank of India in India) is called High Powered Money.
 
Question. Signature of _______ appears on a `2,000 currency note. 
Answer : Governor of Reserve Bank of India (RBI)
 
Question. The value of money multiplier is equal to ___________. 
Answer : the reciprocal of the reserve ratio or 1/Reserve Ratio
 
Question. Loans offered by commercial banks _________ (increase/ decrease) the money supply in the economy. 
Answer : Increase
 
Question. The interest rate paid by the banks to depositors is lower  than the rate charged from the borrowers. This difference between these two types of interest rates is called ______. 
Answer : ‘spread’
 
Question. When the banks lend to any person, a new deposit is opened in that person’s name. Thus, money supply in the economy increases to old deposits plus new deposits plus_______.
Answer : Currency held by the public
 
Question. There is a limit to money or credit creation by banks, and this is determined by the central bank (RBI). The RBI decides a certain percentage of 
(i) _______ which every bank must keep as reserves, called 
(ii) _______. 
Answer : (i) Net total demand and time deposits. 
           (ii) Legal Reserve Ratio 
 
Question. If the Reserve Ratio is 20% and the primary deposits are `100, the total lending by the banking system will be ______. 
Answer :`400
 
Question. M1 measure of money supply is defined as follows: M1= CU +DD where, CU is Currency (notes plus coins) held by the public and DD is ‘net’ demand deposits held by commercial banks. What does word ‘net’ imply here? 
Answer : Only deposits of the public held by the banks are to be included in money supply. The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of money supply.
 
Question. The currency issued by the central bank can be held by the public or by the commercial bank, and is called the ______ . 
Answer : high powered money
 
Question. An increase in Legal Reserve Deposit Ratio increases the credit creation power of the commercial banks (bankingsystem). True/False? Give reason. 
Answer : False: An increase in Legal Reserve Deposit Ratio will decrease the credit creation power of the commercial banks (banking system) since credit creation is inversely related to the Legal Reserve Ratio.
Credit creation = Primary deposits × 1/ Legal Reserve Ratio
 
Question. __________ measures the amount of money that the banks are able to create in the form of deposits with every initial deposit. 
Answer : Credit multiplier/Money multiplier/Deposit multiplier
 
Question. Value of Money Multiplier _______ (increases/decreasesremains unchanged) with an increase in Cash Reserve Ratio. 
Answer : Decreases
 
Question. State, whether the following statement is true or false:‘All financial Institutions are banking institutions.’ 
Answer : False
 
Question. ______________ is the rate of interest at which central bank lends to the commercial banks for long-term. 
Answer : Bank Rate
 
Question. _____ is the agent and adviser to the Government of India. 
Answer : Reserve Bank of India. (RBI)
 

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CBSE Class 12 Macroeconomics-Money Creation(Updated March 2014)

CBSE Class 12 Macroeconomics-Money Creation(Updated March 2014)

CBSE Class 12 Macroeconomics-Money Creation(Updated March 2014)

CBSE Class 12 Macroeconomics-Money Creation(Updated March 2014)

CBSE Class 12 Macroeconomics-Money Creation(Updated March 2014)

Please click the link below to download pdf file for CBSE Class 12 Economics Money And Banking Notes

Part A Microeconomics Chapter 01 Introduction to Micro Economics
CBSE Class 12 Economics Introduction
Part A Microeconomics Chapter 02 Theory of Consumer Behaviour
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Part A Microeconomics Chapter 03 Production and Costs
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Part A Microeconomics Chapter 06 Non-Competitive Markets
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Part B Macroeconomics Chapter 03 Money and Banking
CBSE Class 12 Economics Money And Banking Notes
Part B Macroeconomics Chapter 04 Determination of Income and Employment
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