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Money

The document discusses the quantity theory of money, explaining that there is a direct relationship between money supply and price level, as money supply increases the price level also rises, and it presents Fisher's transaction approach and the Cambridge version of the quantity theory of money. The document also covers the concepts of money multiplier and different measures of money supply.

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Shubham kumar
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62 views21 pages

Money

The document discusses the quantity theory of money, explaining that there is a direct relationship between money supply and price level, as money supply increases the price level also rises, and it presents Fisher's transaction approach and the Cambridge version of the quantity theory of money. The document also covers the concepts of money multiplier and different measures of money supply.

Uploaded by

Shubham kumar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Money

By
Neeloy Gupta
Faculty & In-Charge, Department of Economics,
T.H.K Jain College, Kolkata
&
Guest Lecturer, Department of Economics, Rabindra Bharati University
Money & functions

• What is Money?? • Functions of Money:

• According to Prof. Walker,


“Money is what money
• Medium of exchange
does”. • Measure of value
• Store of value
• According to Kent, • Transfer of value
“ Money is anything which is
commonly used and
• Standard of Deferred
generally accepted as a payment
medium of exchange”.
Types of Money
• Token money

• Fiat Money

• High Powered Money: It refers to the total liability of the


monetary authority of the country. It is consist of-
i) Currency held by the public
ii) Cash reserves with commercial banks
iii) Required reserves of commercial banks to be maintained with
Central Bank
iv) Other deposits with Central Bank
It is also known as monetary base of the economy or the liability
of the Central Bank.
Measures Of Money Supply
• There are different measures in money supply which are
mention below.

• M1 = Currency in the hand of the public + Demand deposition


in the commercial bank + other deposits with the central
bank.(in case of India it is RBI)

• M2= M1 + Post office savings Bank Deposits

• M3= M1 + Time/Term Deposits in the Commercial Banks.


Measures Of Money Supply

• M4= M1+ Post office Savings Bank Deposits +Term Deposits


in the commercial bank.

• It is important to note that, from M1 to M4 , the liquidity


decreases.
Balance Sheet of RBI & Commercial Banks

Balance Sheet of RBI

Liability Side Asset Side

Notes in Circulation Foreign Assets

Deposits of Commercial Banks Loan to Govt. & Commercial Banks

Balance Sheet of Commercial Banks

Liability Side Asset Side

Demand deposits Cash reserves(cash at hand)


Loans
Bonds
QUANTITY THEORY OF MONEY
Statement

• Quantity Theory of Money (QTM) tells that


there is a direct relationship between money
supply & price level of an economy, i.e. as
money supply increases, at the same rate price
level of an economy also rises.
Versions Of QTM

QTM
Fisher’s Version

Cambridge
Version
Fisher’s Transaction Approach
Assumptions:
• Economy is at full employment situation.
• Operation of Say’s law (Say’s law tells that
supply creates its own demand)
• Money is used only as a medium of exchange.
• Velocity of money is constant.
• Monetary authority of the Country sets money
supply.
Fisher’s Transaction Approach
Fisher’s transaction version can be explained by
the following equation:
• MV= PT
where,
M = Money Supply
V = Velocity of money
P = Price level
T = No of transactions
MV= Money Supply & PT= Money Demand
Fisher’s Transaction Approach
𝑀𝑉
• P=
𝑇
As ‘V’ & ‘T’ are constant, so P will increase as
the rate M increases.

• Extension-I
Assuming that V is not fixed then P will not
increase at the same rate as M rises.
Fisher’s Transaction Approach

• Extension-II
Now introduce bank deposit in the present
version & equation becomes:
MV + M′V′ = PT, where M′ is the bank
money supply & V′ is the velocity of bank
money.
𝑀𝑉+M′V′
or, P = 𝑇
𝑀
As V , V′, , T are constant, so P will
𝑀′
Cambridge Version
• Several economists from Cambridge University developed
the equation, the equation is Md =kPY,
• Md denotes Money Demand

• k stands for the proportion of the income people hold.

• P stands for Price Level

• Y stands for real output


Cambridge Version
• On the other side, monetary authority of the
country sets money supply, ‘M’.
• Therefore at equilibrium,
Md = Ms
or, kPY = M
or, P = M/k Y
• Holding the assumptions (k is constant & Y is
constant due to full employment), the version
shows that Price level rises with the rise in
money supply.
Relationship between the two versions

• Let us assume that V=1/k, use this at any version of Quantity Theory
of Money (QTM), then we would reach to the another version of
• QTM.

• Let’s start with Cambridge version. We know the Cambridge equation

• Equation M=kPY

• Putting V=1/k, we get

• MV=PY.

• This state that as peoples desire to hold money rises, i. e ‘ k’ rises, then
V fall, so velocity of money falls & vice versa.
Money Multiplier
Concept
• Money Supply (M) & High powered money (H) are
linked through money multiplier. There are four
assumptions;

Assumptions:
i) The system is fractional reserve system.

ii) Public maintain a fixed ratio of currency to deposit,


so that currency-deposit (C/D) ratio is fixed.
Concept & Derivation
• Assumptions:
iii) Central Bank of the country changes the supply of
High Powered Money.

iv) Supply of money consists of currency & bank


deposits.

The two equations have become highly instrumental


here:
M=C+D ……….i)
H= C+R ………..ii)
Derivation
• Dividing i by ii, we get,
M/H =(C+D) / (C+R)

Or, M/H = (C/D +1)/(C/D + R/D)


or, M = (C/D +1)/(C/D + R/D) . H
Or, M = mm. H
Where mm stands for money multiplier,
Or, mm = M/H
Conclusion

i) The larger the R/D ratio, the smaller the


money multiplier.
ii) The larger the C/D ratio, the smaller the
money multiplier.
iii) If H increases, given mm then also M
increases.

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