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Class 12 Money and Banking: cheat sheet
CBSE Social Science. What money does, the measures M1 to M4, how banks create credit and the money multiplier, and how the RBI controls money supply with the CRR, bank rate, repo rate and open market operations.
Key ideas
- Barter needs a double coincidence of wants; money removes this as a medium of exchange, a unit of account and a store of value.
- Currency notes and coins are legal tender and fiat money; cheques and demand deposits can be refused, so they are not legal tender.
- Banks keep a fraction of deposits as reserves and lend the rest; loans come back as deposits, so deposits grow by a multiple of the first deposit.
- The higher the reserve ratio, the smaller the money multiplier and the less credit banks can create.
- High powered money is currency with the public plus bank reserves, issued by the central bank.
- Raising the CRR, bank rate or repo rate, or selling bonds, lowers money supply; lowering them, or buying bonds, raises it.
- The RBI is the lender of last resort; moral suasion and margin requirements are qualitative tools.
Remember
| Money multiplier | 1 ÷ reserve ratio (r = 20% gives 5) |
| Total deposits created | initial deposit × 1 ÷ r |
| Total loans | total deposits − initial deposit |
| Round 2 deposits | deposit + deposit × (1 − r) |
| M1 | currency with the public + net demand deposits |
| M2 | M1 + savings deposits with post office savings banks |
| M3 (broad money) | M1 + net time deposits of banks |
| M4 | M3 + total post office deposits (excluding NSC) |
Watch out
- Taking the multiplier as the reserve ratio itself instead of its reciprocal.
- Building M3 from M2: M3 = M1 + net time deposits, not M2 + time deposits.
- Thinking an open market purchase of bonds by the RBI reduces money supply (it adds reserves).
Worked example
Suppose currency with the public is ₹3,210 crore, net demand deposits ₹2,030 crore, savings deposits with post office savings banks ₹270 crore, net time deposits of banks ₹6,010 crore, and total post office deposits (excluding NSC) ₹610 crore. (a) Find M1, M2, M3 and M4. (b) Which are narrow and which broad money? (c) Which is most liquid?
Working: M2 = M1 + PO savings; M3 = M1 + net time deposits; M4 = M3 + total PO deposits
Answer: (a) M1 ₹5,240 crore, M2 ₹5,510 crore, M3 ₹11,250 crore, M4 ₹11,860 crore (b) M1, M2 narrow; M3, M4 broad (c) M1
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