Money and Monetary Policy

Money and credit:

• Medium of exchange: money is the go-between in buying and selling, which ends the need for a double coincidence of wants.
• Unit of account: prices of all goods are stated in money.
• Store of value: money can be kept and spent later.
• Regulating consumption is not a function of money; that is a job of government policy.
• Collateral: an asset the borrower pledges (land, gold, a deposit) as a guarantee of repayment. The lender can sell it if the loan is not repaid.
• Nominal interest rate: the percentage by which the money paid back exceeds the money borrowed.
• Real interest rate = nominal rate minus the rate of inflation.

The RBI's measures (NCERT Class 12):

• M1 (narrow money) = currency with the public + demand deposits with banks + other deposits with the RBI.
• M2 = M1 + savings deposits with post office savings banks.
• M3 (broad money) = M1 + time deposits with banks. M3 is the most commonly used measure, also called aggregate monetary resources.
• M4 = M3 + total deposits with post office savings organisations (excluding NSC).
• M1 and M2 are narrow money; M3 and M4 are broad money. Liquidity falls from M1 to M4.
• Bankers' deposits with the RBI and bank reserves are part of reserve money (M0), not of M1.

The rules (NCERT Class 12):

• Reserve money (high-powered money, M0) is what the RBI creates: currency plus banks' reserves with it.
• Money supply = money multiplier × reserve money.
• The multiplier depends on the currency-deposit ratio (cash people hold compared with their deposits) and the reserve-deposit ratio (reserves banks keep, set mainly by the CRR).
• If people hold more cash and less in deposits, the multiplier falls.
• If the RBI raises the CRR, the multiplier falls; cutting it raises the multiplier.
• With no cash held by the public, the multiplier is simply 1 divided by the reserve ratio.

The tools:

• Repo rate: the rate at which the RBI lends overnight to banks against government securities (the securities are the collateral). It is the main policy rate.
• Standing Deposit Facility (SDF): introduced April 2022; banks park surplus funds with the RBI without collateral. The SDF rate replaced the fixed reverse repo rate as the floor of the LAF corridor.
• Marginal Standing Facility (MSF): emergency borrowing, the ceiling of the corridor; the bank rate is kept equal to it.
• CRR (cash reserve ratio): share of net demand and time liabilities (NDTL) a bank must keep as a cash balance with the RBI. SLR (statutory liquidity ratio): share of NDTL a bank keeps with itself in liquid assets such as gold, cash and government securities.
• Open market operations: the RBI buys securities (or foreign exchange) to add money and sells them to remove money.
• Transmission of a policy change is judged by bank rates: the weighted average lending rate, the weighted average domestic term deposit rate and the one-year median MCLR.
• Public debt and public revenue are tools of fiscal policy (the government), not monetary policy.
• Figures change: in late 2025 the CRR stood at 3% (cut from 4% in four steps announced in June 2025) and the SLR at 18%. Check the current values before an exam.