Monetary

Economics II B.A
Introduction

Monetary theory defines and explains the behavior of money and its inter-
relations with the functioning of an economy.The actual performance of
an economic system is greatly influenced by the functioning and
malfunctioning of money. Money is vital for any economic system and all
recognise the importance of money. What is not so clear to all is nature of
money and its functions.

Definitions of Money: The term money like many terms in economics has
been defined in different ways by different authors.Some of the
definitions define money in terms of its functions or in legal terms or on
the basis of general acceptability. Some of the general definitions of
money are listed below

1) Walker, Hartley, Withers, Sidwick and others have focussed on

Definitions contd...
They have defined money as anything that is genrally accepted as a
medium of payment and which is denominated in terms of a common unit
of account

Hartley has defined money as “ the stuff with which we buy and sell
things”

Walker “ Money is that money does”

2) Money has been defined in legal terms by Knapp in Germany and

Hawtrey in Britain contending that money is what the law has proclaimed
as money. Certain things are recognised by the state as money for the dual
purpose of acceptability and for clarifying the legal position of debtor and
creditor in discharging obligations calling for money payments
 Definitions Contd….
Hawtrey defines money as “ the means exhibited by law for the payment
of debt.”

This definition of money presents the legal view of money.

3) General acceptability definitions of Money

Seligman defines money as “ a thing that possesses general acceptability

Robertson defines money as “ anything which is widely accepted in

payment for goods or in the discharge of other kinds of business
obligations.

Crowther defines money as “ anything that is generally acceptable

as a means of exchange and that at the same time acts as a measure and a store of
value.”

DIFFERENT APPROACHES TO THE DEFINITION OF MONEY

1. Traditional/Conventional Approach: In this approach, money is regarded

only as a medium of exchange. This definition focuses on characteristics
like spendability, liquidity etc.

M = C + DD where C stands for currency and DD demand deposits.

2. Monetarist Approach: associated with Friedman and other quantity

theorists . Friedman defined money as “ the temporary abode of purchasing
power “

M = C + DD + TD
3. Liquidity Approach-associated with the names of Gurley and Shaw and the
Radcliffe Committee. In this approach the consituents of money have been
further widened to include in money the monetarist definition plus the liabilities
of the non banking intermediaries.

M= C+DD+TD+NBFIs

Gurley and Shaw in their book Money in a Theory of Finance in 1960 believe
that money should include the liabilities of NBFIs as they also represent liquid
assets closely substitutable for money.They define money supply as the
weighted sum of all assets,weights being assigned to each item on the basis of
the degree of substitutability.

Gurley and Shaw have also made an important distinction between inside
money and outside money
Outside money comes from outside the private sector and represents wealth for
which there is no corresponding debt. It is an asset to someone without being a
debt for anyone else. Gold coins and currency notes may be considered as outside
money. Inside money on the other hand is created against private debt. It is
typified by bank deposits and other assets created by financial intermediaries, the
assets on one side corresponding to the liabilities on the other side of the balance
sheet.

4. The Central Bank Approach:: Broadest approach to the definition of money. It

extends the scope of the constituents of money as the total amount of credit
extended by a wide variety of sources.

M= C+DD+TD+NBFIs+CUA
 EVOLUTION OF MONEY
The word money is believed to originate from a temple of Juno,one of Rome’s seven hills.
In the ancient world Juno was often associated with money. The temple of Juno Moneta at
Rome was a place where the mint of ancient Rome was located.

The origin of money is not known because of the non availability of recorded
information. It is deep rooted in antiquity. The evolution of money happened most
probably because of the difficulties of the barter system.The evolution of money has been
a secular process and shall continue to do so. The development of money in its present
form can be historically traced as it has passed through different stages in accordance
with the growth of human civilization
 Stages in Evolution of Money
1. Animal Money
2. Commodity Money
3. Metallic Money
4. Paper Money
5. Credit Money
6. Electronic Banking Stage
Classification of Money
Broadly speaking three main types of money exist in an economy

1. Metallic Money
2. Paper Money and
3. Credit Money

Economists however further classify them into many other forms.Some

important classifications of money are given below

A) Money proper and Money of Account-This distinction was given by

Keynes. He said “ the money of account is the description or title and
money is the thing which answers the description”
Money proper or actual money refers to the money in circulation in the
country. It is the medium of exchange and means of payment.Example the
rupee

Money of account is that in which accounts are maintained. Prices of

goods and services, general purchasing power,debts are all expressed in
terms of the money of account.Generally money proper and money of
account are the same but sometimes the two may be different.

B) Commodity Money and Representative Money; is further divided into

commodity money and representative money.Commodity money is made
of a certain metal and its face value is equal to its intrinsic value.It serves
as the medium of exchange and also a store of purchasing power.It is also
known
as full bodied money or standard money. The money proper in circulation
which is not full bodied is called representative money.Its face value is
greater than its intrinsic value. Paper currency is an example of
representative money.

C) Legal Tender and Optional Money- On the basis of acceptability

money is divided into legal tender and optional money. Legal tender
money is enforced by law . No one can refuse to accept it as a means of
payment.Legal tender is further divided into 2 namely limited and
unlimited legal tender

Optional money has no legal sanction . It is money which may or may not
be be accepted as a means of payment. Example cheques, drafts etc
D) Metallic Money-Money made of metals ie coins made out of metals.
Metallic coins is of 2 types

1. Standard Money
2. Token Money

E) Paper Money. Consists of currency made of paper issued either by

the government or by the Central Bank of the country. Paper money is
of four types

1) Representative paper currency

2) Convertible Paper Currency
3) Inconvertible Paper Currency
4) Fiat Money and
5) Credit Money
 Functions of Money
Functions of Money classified into

a) Primary functions
b) Secondary functions
c) Contingent functions

Primary Functions-described by Kinley as the essential functions of money.Also

known as the original, fundamental or basic functions of money. These are the
functions of money which are performed at all times under all conditions.There are
2 primary functions of money.

d) Medium of Exchange-facilitates trade by providing a medium which everyone

is willing to accept in exchange for goods and services or
payment of debt.Known as means of exchange aor circulating medium.
Universal function that is so basic that money is defined as generalized
purchasing power.The use of money as medium of exchange has broken
up an exchange of goods for goods into 2 transactions-purchase sand
sales. THis function has facilitated exchange transactions at all places and
times and given a great degree of freedom with regard to quantity and
quality of goods they desire to buy and sell.Money acting as the medium
of exchange has perfected the price mechanism.

b) Common Measure of Value-this function enables money to express the

values of all commodities.Also known as standard of value,unit of
account,common denominator of value.Money serves as a unit in terms of
which the value of goods and services is measured and expressed as a
price.
The price mechanism which helps in obtaining efficient allocation of
resources in an economy is dependent upon this function.Without the
price system the value of goods and services would have to be expressed
in terms of all other goods and services available leading to innumerable
exchange rates. So money measures value but this is not a constant .
Changes in money supply will change the purchasing power of money ie
the value of goods and services in terms of money is likely to vary.Money
serves as a satisfactory measure of value at a given time and a limited area
.

Secondary Functions of Money - derived functions of money.

a) Standard of deferred payments:-acts as a medium of exchange and

unit of account not only for current transactions but it
as a standard of deferred payments when obligations to make future
payments are stated in terms of it. These obligations have their origin in
two general types of transactions Namely credit and debt transactions and
when there is an agreement to deliver goods and services at some future
point for an agreed sum of money in the future.

2) Store of Value-Money is generalized purchasing power. Due to its

general acceptability money embodies value in its most general form.
When money is retained or stored for any period of time it serves as a
store of value. Store of value function implies the shifting of purchasing
power from the present to the future.

3) Transfer of value from one place to another and from one person to
another
Contingent Functions of Money
David Kinley has given these functions. These functions arise from the
characteristics of the stage of economic life in which money is used.
Higher the level of development greater is the importance of these
functions

1) Distribution of social Income

2) Equalisation of Marginal Utility in Expenditures
3) Basis of the Credit System
4) Imparting a General Form to Capital
 Static and Dynamic Functions of Money
Paul Einzig gave this classification

By its static functions money serves as a passive technical device ensuring a better
operation of the economic system.Also known as the traditional, fixed technical or
passive functions of money. These are the functions which are performed by
money under all conditions without bringing about any change in the economic set
up. It is helpful in economic life in a number of ways and facilitates economic
activities in the fields of production,consumption exchange,distribution etc. It acts
in a passive manner and does not seek to bring about any fundamental change in
the essential character of the economy.Broadly speaking the primary and
secondary functions of money are the static functions of money
Paul Einzig considers money to be the medium through which the price
mechanism operates.It is through the price mechanism that money helps to
establish a balance between demand and supply and reconcile the interests of
producers and consumers. For these functions to be performed efficiently the
stability in the value of money is essential.

Dynamic functions are ones where money tends to exert a powerful influence on
the economic entities like trends in price levels, volume of production,
consumption savings, investment, employment etc. Any change in the volume
and velocity of circulation of money can bring about changes in the real
variables .Therefore money plays an important role in influencing economic
activity. Deficit financing is also only possible in a money economy. So essential
the contingent functions of money are the dynamic functions of money
Unit 1.2 Monetary Standards
Definitions

1. ‘According to Shapiro “ The monetary standard of a nation involves

the overall set of laws and practices which control the quantity and
quality of money in the system.”
2. Kent- “ A monetary standard can be defined as a monetary system
built upon a specific standard of value’
3. Cathcart- “ A monetary standard is the standard that is chosen by a
society for its ultimate standard of value and which also usually
serves as an asset of value promised on demand by debt-money
issuers”

Monetary standard has 2 aspects national and international

Basically monetary standard is national in character because it is intended
to meet the internal requirements of the economy ie it should serve as a
medium of exchange and a store of value .

The international character arises because it has to facilitate international

payments. Thus a sound monetary standard should fulfil two objectives

a)To maintain stability in the internal value or the price level and

b) to maintain stability in the external value of the currency or exchange

rate stability.
Qualities of a Good Monetary Standard

1. Simplicity
2. Elasticity
3. Economy
4. Stability
5. Convertibility
6. Legality
7. Automatic Working
8. Economic Development
9. Others
Types of Monetary Standards
Metallic Standard: Under metallic standard the monetary unit is defined in
terms of some metal like gold or silver. The standard coins are full bodied
legal tender . For a country to operate on a metallic standard a country
must keep a)

a) Its monetary unit at a constant value in terms of the selected metal.

b) The monetary unit is convertible into a selected metal at constant
value.

Metallic standard is of two types

1. Monometallism and 2 Bimetallism

Monometallism refers to a monetary standard in which the monetary unit is
defined in terms of a single metal either gold or silver.Only one metal is used as
standard money .

Features of Monometallism

1. Standard coins are defined in terms of only one metal

2. Standard coins are accepted as unlimited legal tender
3. There is free coinage
4. No restrictions on the import or export of gold
5. Paper currency can also circulate but it is convertible into standard metallic
coins.
Types of Monometallism

1. Silver Standard
2. Gold Standard

Merits of Monometallism

3. Simplicity
4. Public confidence
5. Promotes Foreign Trade
6. Avoids Gresham’s Law
7. Self Operative
Demerits of Monometallism

1. Costly Standard
2. Lacks elasticity
3. Hampers Economic Growth

BIMETALLISM

According to Chandler “ A bimetallic or double standard is one in which

the monetary unit and all types of a nation’s money are kept at constant
value in terms of gold and also in terms of silver

Features

1. It is based on two metals,simultaneously maintenance of both gold and

silver standard
2. There is free and unlimited coinage of both metals

3. The mint ratio of exchange between gold and silver is fixed by the state.

4. Two types of coins are in circulation at the same time inthe country.

5. Both are standard coins. Ie extrinsic value equals intrinsic value

6. Both the standard coins are unlimited legal tender

7. There is free import and export of both the metals

MERITS

1.Convenient Full Bodied Coins for both large and small transactions
2. Price Stability

3. Exchange Rate Stability

4. Sufficient Money Supply

5. Maintenance of Bank Reserves

6. Low Interest rates

7. Stimulates Foreign Trade

DEMERITS

1. Operation of Gresham’s Law-Bad money drives good money out of

circulation.
2. Inequality between the Mint and the Market rate of exchange

3. No price stability.

4. Payment Difficulties

5. Encourages speculative Activity.

6. No Stimulus to Foreign Trade.

7. Costly Monetary Standard.

GRESHAM’S LAW -Named after Sir Thomas Gresham who was the
Chancellor of the Exchequer during the reign of queen Elizabeth I. In
order to bring about reform in the currency system she introduced new
standard coins in the hope that they would
Replace the old debased coins in the country. But surprisingly the new
goins disappeared from circulation. She sought an explanation for this
who then gave the law which states that bad money drives good money
out of circulation.

A bimetallic standard there are ratios of exchange between gold and silver.
One is the mint ratio determined by the state and the other the market rate.
When there is a disparity between the mint parity rate and the market rate
of exchange the bad money( overvalued money) at the mint drives the
good money(undervalued money) at the mint out of circulation.Thus
ultimately a single metal money will remain in practice.Thus bimetallism
is a temporary phenomenon. This law operates when

1. Good money is hoarded. 2. Good money is melted and 3. Exported.

This law will operate if the following conditions are satisfied

1. Usefulness of good money.

2. Fixed Parity ratio
3. Sufficient Money Supply
4. Acceptability of Bad Money.
5. People should be able to distinguish between good and bad money.
6. Development of banking habit- applies in the absence of banking
habits generally.
7. Convertibility
 Gold Standard
Gold standard is the most popular metallic standard. Under this standard the
monetary standard is defined in terms of a fixed quantity of gold of a certain
fineness. Widely accepted standard in most parts of the world during the late
19th century and early 20th century

According to Robertson “ Gold standard is a state of affairs in which a country

keeps the value of it monetary unit and the value of a defined weight of gold at
equality with one another.”

Features of Gold Standard

1.The monetary unit is defined in terms of certain weight and fineness of gold
2. All gold coins are standard coins and are unlimited legal tender.

3. All other types of money(Paper currency or token money )are freely

convertible into gold

4. There is free and unlimited coinage

5. There is free and unlimited melting of gold

6. Import and export of gold is free and unlimited

7. The monetary authority is under permanent obligation to buy and sell

gold at a fixed price without limit.
Functions of Gold Standard

1. To regulate the volume of currency-concerned with stabilising the

internal value of the currency.
2. Exchange rate Stability.

Working /Functioning of the Gold Standard

In the gold standard the restoration of international payments

disequilibrium is supposed to be the automatic result of the gold flows
upon the economies of both the gold losing losing and gold receiving
countries.The equilibrium in BOP position of countries on the gold
standard was automatically adjusted through the movement of gold
The theory of gold movements states that gold flows out of a country with
a deficit in its BOP and gold flows into a country with a surplus in its
BOP. Gold flows out of a country with a relatively high cost price
structure and flows into a country with a relatively low cost-price
structure It is this movement of gold which will restore the equilibrium in
BOP in both the countries.

Suppose there are two countries A and B on the gold standard and suppose
country A has an adverse BOP and country B has a surplus BOP. This
disequilibrium will be automatically corrected through a mechanism
involving the following steps

1. Gold Movement-Outflow of gold from A and inflow of gold to B.

2. Changes in Money Supply-In country A money supply will increase and
in B money supply will decrease.

3. Changes in prices and economic activity-Decrease in money supply

will lead to reduced wages, prices, investment, output etc. Reverse will
take place in the gold receiving country

4.Changes in Imports and Exports. Fall in prices in country A will lead to

increased exports and reduced imports. In country B there will be reduced
exports and increased imports due to higher price level

5. Equilibrium in BOP will be restored-The changing exports and imports

in country A and B will continue till equilibrium is restored
Rules of Gold Standard
1. There should be free import and export of gold between the countries
that adopt the gold standard.
2. Subordination of Credit policy to Gold Movements-Golden rule of
the gold standard is expand credit when gold is coming in and
contract credit when gold is going out.
3. International Cooperation-various independent objectives of
monetary policy must be subordinated to the international monetary
objective ie exchange rate stability.
4. Flexible economy.-there should be high degree of flexibility and
competition.
5. Disturbing capital movements should not be there
6. Absence of Trade Restrictions is a necessary condition for the
successful functioning of the gold standard. No form of tariff or non tariff
barriers should be imposed by the countries.

7. The monetary authorities in the gold standard countries should maintain

their gold parities by buying and selling gold in unlimited quantities at
fixed rates.

8. Every gold standard country should try hard to achieve equilibrium in

BOP so that gold flows may be well regulated.

9. It is essentially a laissez-faire standard

Collapse of the Gold Standard
The gold standard functioned with reasonable success prior to 1914.This
was mainly because the conditions which were necessary for the
successful functioning of the gold standard were mostly fulfilled and
countries abided by the rules of the gold standard.However the first World
War created abnormal conditions which resulted in many countries going
off the gold standard . However after the war many countries went back to
the gold standard but of a different type. But this did not last for many
years and by the late 1930s most countries were off the gold standard
except for USA.
Causes for the Breakdown of the Gold Standard

1. The war and post-war adjustments led to a maldistribution of the

gold reserves of the world between different countries.
2. The monetary authorities had no longer the exclusive devotion to the
aims of the gold standard which they had before the war,
3. The Central Bank of countries due to divided loyalties and technical
problems failed to observe the rules of the gold standard.
4. Under the influence of narrow nationalism many countries gave up
free trade and adopted restrictionist tade policies.
5. Inflexibility of internal prices

6. The reason for the failure of the post war gold standard was due to the
unrealistic and improper parities announced by the countries

7. Extensive Use of the Gold Exchange Standard

8. Excessive international indebtedness

9. Erratic movement of short term capital caused by rumors of war,civil

strife

10. The Great Depression

Types of Gold Standard
1. The Gold Coin Standard
2. The Gold Bullion Standard.In this system though gold is
theoretically the standard of value there is little or no gold in
circulation.There is no free coinage of gold and whatever gold coins
are in circulation are melted and formed into bars and kept with the
central bank.Every unit of domestic currency can no longer be
converted to gold on demand.it is legally convertible into gold bars
of certain weight.

Features of the Gold Bullion Standard

3. A specified quantity of gold of a certain weight and fineness is

adopted as the standard unit of value.
2. There are no gold coins in circulation and the normal currency consists
of paper money and token coins.

3. All legal tender money in circulation is redeemable in specified

minimum amounts at par in gold bullion on demand.

4. The Central bank undertakes the purchase and sale of gold in unlimited
amounts at fixed prices.

5. Gold kept as reserves constitute only a faction of the currency in

circulation.

6. There is free import and export of gold in any form.

3. The Gold Exchange Standard- This is a means of further
economizing on the use of gold whereby a country seeks to redeem its
currency not directly into gold but into the currency of a country
following either the gold coin or bullion standard.There were 2 classes of
gold exchange countries

a) Those who maintain virtually no gold reserves at home and therefore

depend entirely upon the gold reserves of other countries.

b) Those which maintain partial gold reserves at home and which count as
additional reserve their deposits and short term investments in other gold
standard countries
Features of the Golf Exchange Standard
1. The monetary unit is declared to be a specific quantity of gold but
gold as a medium of exchange is non-existent.
2. Domestic currency in circulation is inconvertible into gold but
convertible into the currency of another country on the gold
coin/bullion standard in specified amounts.
3. There is no direct relationship between the domestic currency and
gold.
4. The reserves of foreign exchange and foreign bills serves the purpose
of a gold reserve.
The Gold Reserve Standard
England went off the gold standard in 1931, followed by America and
France in 1933 and 1936 respectively. However these countries still
considered gold as their basic monetary stock which they wanted to use
for maintaining exchange rate stability. England established the Exchange
Equalization Account fund for this purpose in 1932. America and France
also set up similar funds. In 1936 these three countries formed the
Tripartite Monetary Agreement. It provided that gold movements could
take place between these funds for the purpose of stabilizing the exchange
rates. Later Belgium, Holland and switzerland also joined the agreement
To carry out the provisions of the agreement, the exchange stabilization
fund of each country was to sell or purchase gold and foreign currency at
a fixed rate to its counterparts. Each fund used its own currency to acquire
foreign exchange and gold it enabled the fund to intervene in the foreign
exchange market in order to stabilise its exchange rate.However this
lasted for only a short period from 1936-39.

The Gold Parity Standard; Came into existence with the establishment
of the IMF in 1944. Under this system all member countries had to
declare the par value of their currencies in gold solely for the purpose of
determining exchange rates. It established what is known as managed
flexibility in exchange rates. There was no obligation on the part of the
countries to
Maintain a free gold market or provide for internal redeemability of
money.No requirement of minimum gold reserve to be maintained by the
monetary authorities.

The second amendment to the Articles of Agreement of the IMF came

into force from April 1,1978. Since then gold has ceased to have an
official price and is no more the numeraire in which the value of
currencies are expressed.Member countries are now free to deal in gold in
the market without any reference to an official price. Therefore gold has
ceased to have any monetary role at the international level, though some
gold reserves are maintained by the central banks of countries. Currency
issued bears no relationship to gold
Paper standard
Paper standard is a monetary standard in which the paper notes issued by
the Treasury or the Central Bank or both circulate as unlimited legal
tender . Token coins also circulate side by side with paper notes.The
money in circulation is not convertible to gold.

Features

1. The money in circulation has little or no value within itself as a

commodity.
2. It is not redeemable into gold or any other commodity.
3. Its purchasing power is not maintained at par with gold
4. It is managed by the monetary authority
According to British historian Toynbee paper money was used by Chinese
kings as early as 970 A.D but in the rest of the world it came much later.
The origin of paper money was not from governments but private
individuals and banks who acted as warehouses for the storage of coins
and the paper bills they issued were claims to these coins. Government
issue came much later initially as representative money .But after the
collapse of the gold standard world over paper currency which is
inconvertible has been adopted as the standard.

Merits of Paper Standard

1. Helpful in achieving economic growth

2. The use of paper currency helps in maintaining internal price stability.
It frees the country from the deflationary and inflationary effects of gold
flows which can be cumulative and lead to depression or excessive
inflationary pressures.

3. Paper currency is considered to be nationalistic and insulates the

economy from the effects of international cyclical changes.Monetary
authorities can frame and pursue independent monetary policy.

4. Helps greatly during times of emergencies or wars as these can be

easily financed through deficit financing.

5. The managed paper standard allows for more effective and

automatic regulation of the exchange rate, whereas under the gold
standard these remained more or less fixed.

6. Paper standard is a more economical standard.

7. The paper standard releases precious metals for non-monetary

purposes.

8. Paper currency is portable,cognizable, and easily transferable and

therefore smoothens rapid exchange in modern trade and commerce.

Demerits

1. Paper currency offers wide scope for poor governments to

over issue the currency.

2. The system does not provide a monetary basis in common with other
national monetary systems.

3. Though nations are able to pursue an independent monetary policy , the

economic interdependence between nations sets limits to the freedom with
which a country may follow its domestic monetary policy.

4. Paper standard interferes with free international movement of trade and

factors of production.

5. It is doubtful whether a managed paper standard ensures internal price

stability.
6. The issue of paper currency requires an efficient management and
deliberate policy for its regulation, whereas gold standard is an automatic
standard

7.Though managed by the central bank it cannot operate freely without

political considerations.

8. More Elastic Standard

Principles of Note Issue

There are two principles of note issue namely the currency principle and
the banking principle
 1. Currency Principle-Also known as the Security Principle asserts that
a sound system of note issue is one which enjoys the greatest
confidence of the people.Hence convertibility into gold or silver will
give confidence to the people in the system.Under this system note
issue has to be fully backed by metallic reserves.
2. Banking Principle-gives importance to the quality of elasticity in the
monetary system.Known as the Elasticity principle.Under this
principle only a part of the total currency notes issued is backed by
metallic reserves.

Methods of Note Issue

Under the currency principle

a) Simple Deposit system

The partial deposit system comes under the banking principle. The
different versions are given below

1. Maximum Fiduciary Issue System:-Fiduciary issue implies the

issue of currency notes without metallic backing. Under this system
the government fixes the maximum limit up to which the central
bank can issue notes without any metallic reserves. This is
determined after taking into consideration the requirements of the
economy.This limit can be revised by the government from time to
time.This system was followed in France from 1870 to 1928.
England and France also adopted this system in 1939 and 1941
respectively
2. Fixed Fiduciary Issue System-Here the central bank is authorised by
law to issue only a fixed amount of notes uncovered by any metallic
reserves.Up to this limit notes are issued against securities. All notes
issued in excess of the fixed limit should be backed by 100 per cent
metallic reserves.The fiduciary limit can be changed only by a change in
the law.

This system was introduced in England in 1814 and continued till 1939.
Other countries like Italy, Norway and Finland had adopted this system
prior to 1926.

3. Proportional reserve System:-Under this system a certain proportion of

notes issued by the central bank is backed by metallic reserves and the
rest is backed by approved securities.The proportional reserve generally
varies between 25 and 40 per cent
of the total note issue. France adopted this system in 1928. In india this
system was used between 1927 and 1956 under which 40% of the notes
issued was backed by a reserve of gold and sterling securities and the
balance of 60% by rupee securities.

4. Minimum Reserve System- This system requires the monetary authority

to maintain a minimum reserve prescribed by law against note issue,
whatever be the quantity of notes issued. This system has been in force in
India since 1956. The RBI is required to hold a minimum reserve of Rs
200 crores of which 115 crores must be in the form of gold. This system
ensures maximum elasticity as compared to the other methods of note
issue