Money
Evolution of Money
- Definition: Money is anything that is generally accepted as a medium of exchange, a unit of account, a standard of deferred payment, and a store of value.
- Evolutionary Stages of Money:
- Barter System: Direct exchange of goods for goods (Goods-for-Goods economy). Major limitation: Lack of double coincidence of wants.
- Commodity Money: Use of valuable commodities like cattle, salt, shells, or furs as a medium of exchange.
- Metallic Money: Use of precious metals like gold and silver coins.
- Paper Money (Fiat Money): Currency notes issued by the central authority/government with legal tender status.
- Credit / Bank Money: Demand deposits, cheques, drafts, and electronic money (Digital currency).
Forms and Supply of Money
A. Legal Tender
- Limited Legal Tender: Money that can be accepted up to a certain legal limit in settlement of a debt (e.g., small coins in some jurisdictions).
- Unlimited Legal Tender: Money that creditors are legally bound to accept up to any amount for the discharge of debts (e.g., Indian Rupee banknotes and coins).
B. Measures of Money Supply in India (RBI Approach)
- M1 = Currency with the public (C) + Demand deposits with banks (DD) + Other deposits with RBI (OD) (Most liquid measure, known as Narrow Money)
- M2 = M1 + Savings deposits with post office savings banks
- M3 = M1 + Net time deposits of commercial banks (Known as Broad Money, most commonly used to measure total money supply)
- M4 = M3 + Total deposits with post office savings organization (excluding national savings certificates)
Economic Concepts Related to Money
| Concept / Term | Core Definition & Feature | Significance |
| Fiat Money | Currency declared as legal tender by government decree, not backed by physical gold/silver. | Standard concept tested under monetary economics. |
| Gresham’s Law | “Bad money drives out good money” from circulation if exchange rate is fixed by law. | A classic economic principle frequently asked in civil service examinations. |
| Velocity of Circulation | The average number of times a unit of money changes hands in an economy during a given period. | Measures the efficiency and speed of money usage. |
| Narrow Money (M1) | Highly liquid form of money supply comprising currency and demand deposits. | Key monetary aggregate tracked by the Central Bank. |
| Broad Money (M3) | Includes both narrow money and time deposits with commercial banks. | Represents the total volume of money in the economy. |
PYQs
1. According to Gresham’s Law: [Miscellaneous 2012]
(A) Good money drives out bad money
(B) Bad money drives out good money
(C) Hard currency replaces soft currency
(D) Inflation drives out deflation
Answer: (B) Bad money drives out good money
2. Which of the following is considered the most liquid measure of money supply (M1) in India? [Miscellaneous 2018]
(A) Currency with the public + Demand deposits + Other deposits with RBI
(B) Currency with the public + Time deposits with commercial banks
(C) Total Post Office deposits + Demand deposits
(D) Currency with the public + Total bank deposits
Answer: (A) Currency with the public + Demand deposits + Other deposits with RBI
3. Fiat money refers to money that: [Miscellaneous 2019]
(A) Has intrinsic gold or silver value
(B) Is backed by physical bullion reserves 100%
(C) Is authorized by government decree/legal tender and not backed by precious metal
(D) Is used exclusively for international trade
Answer: (C) Is authorized by government decree/legal tender and not backed by precious metal
4. The primary limitation of the barter system of exchange is: [Miscellaneous 2012]
(A) High transport cost
(B) Lack of double coincidence of wants
(C) Excessive government intervention
(D) Rapid generation of inflation
Answer: (B) Lack of double coincidence of wants
5. Which measure of money supply in India is known as “Broad Money”? [Miscellaneous 2019]
(A) M1
(B) M2
(C) M3
(D) M4
Answer: (C) M3