Money and Banking

About this unit

This unit explains what money is, why every modern economy uses it, and how its supply is measured and changed. It shows how commercial banks create money through loans and how the Reserve Bank of India (RBI), the central bank, controls the money supply and credit. These ideas connect to inflation, interest rates and the working of monetary policy.

Key ideas

• Barter has the problem of double coincidence of wants; money solves it.
• Functions of money: medium of exchange, unit of account, store of value, standard of deferred payment.
• Money supply is a stock held by the public; M1 is narrow money and M3 broad money.
• Banks create credit because they keep only a fraction of deposits as reserves.
• The money multiplier links reserves to total deposits.
• The RBI uses repo rate, reverse repo rate, cash reserve ratio, statutory liquidity ratio and open market operations.

How to prepare

Memorise the components of M1 and M3, and the formula money multiplier = 1 ÷ reserve ratio. Learn each RBI tool and the direction in which it moves credit when raised or lowered. Expect short numericals on credit creation and situation questions on controlling inflation.