Question

1) What is the definition of Money?

2) What are functions of Money?

3) What are the ways that allow the Central Bank to control the Money supply in a closed economy. Explain.

Answer 1

1. Money: Money is the generally accepted medium of exchange for goods and services or for repayment of debts. There are different kinds of money supply as described in economics :-

• M1: currency held by public+ Demand Deposits+ Other deposits kept by the central Bank
• M2: M1+ Deposits with the Post office
• M3: M1+ Time deposits with the bank
• M4: M3+ Total deposits with the bank

2. Functions of the Money:-

• Money as the medium of exchange:

​​​​​​​The first and the foremost function is that it is an accepted medium of exchange. It is used in making payments for all the transactions and you don't have to look for a counter party as in the case of a barter system.

• Money as Measure of Value:

  Money serves as a unit of account or a measure of value. Different goods produced in the country are measured in different units. Without a common unit, exchange of goods becomes very difficult. Values of all goods and services can be expressed easily in a single unit called money.

• Money as the Standard of Deferred Payments:

  Deferred payments are payments which are made some time in the future. Debts are usually expressed in terms of the money of account. Loans are taken and repaid in terms of money.The use of money as the standard of deterred or delayed payments immensely simplifies borrowing and lending operations because money generally maintains a constant value through time.

• Money as a Store of Value:

Wealth can be stored in terms of money for future.

3. There are majorly two kind of ways that allow the Central Bank to control the Money supply in a closed economy:-

• A. Quantitative Measures

Inflation/ Deflation	1. Bank Rate Policy	2. Open market Operations	3. Legal Reserve Ratio
	Rate at which central bank lends to commercial banks	Buying and selling of securities by central bank to general public.	There are the following kinds of LRRs:- SLR and CRR
Inflation	Increases the bank rate	Sells government securities	Increase the LRR
Deflation	Decreases the bank rate	Buys more securities	Decrease the LRR

• B. Qualitative Measures
  • 1. Consumer Credit Regulation : This refers to issuing rules regarding down payments and maximum maturities of installment credit for purchase of goods.
  • 2. Central Bank Guidelines : Central bank, being an apex bank and a regulator of other banks; issues oral, written statements, appeals, guidelines, warnings etc. to the banks for their proper functioning.
  • 3. Rationing of credit :The Central Bank controls the Credit granted/allocated by commercial banks.
  • 4. Moral Suasion Psychological : This means that CB also uses informal means of selective credit control.