Money, Banking and Inflation
Money, Banking and Inflation connects monetary institutions with price stability. BIEAP tests money functions, money supply measures, central and commercial banking, credit creation, monetary policy tools, and inflation types and effects.
Core rules
- Money serves as medium of exchange, measure of value, store of value and standard of deferred payment.
- Money supply measures: M1 = currency with public + demand deposits + other deposits with RBI; M2 adds savings deposits with post offices; M3 adds time deposits; M4 adds total post office deposits.
- The RBI performs currency issue, banker to government, banker’s bank, lender of last resort, credit control and foreign exchange management.
- CRR is the cash reserve ratio; SLR is the statutory liquidity ratio. Repo rate is the RBI’s lending rate; reverse repo absorbs liquidity.
- Credit multiplier = 1 ÷ reserve ratio in a simplified model.
- Inflation is a sustained rise in the general price level. Demand-pull inflation arises from excess demand; cost-push from rising costs.
Worked example
If the reserve ratio is 20%, the simple deposit multiplier is 1/0.20 = 5. An initial deposit of ₹1,000 can support total deposits of ₹5,000, assuming no cash leakage and no excess reserves.
Traps
Do not treat CRR and SLR as identical. Do not say repo and reverse repo are the same direction of policy. Inflation hurts fixed-income earners and creditors, but may help debtors. Money supply is not the same as currency with the public. The multiplier is an upper limit, not a guaranteed outcome.