Money, Banking and Inflation
Domain 8 covers the functions of money, money supply measures, commercial-bank credit creation, RBI instruments, and inflation. The exam tests the credit multiplier and the distinction between types of inflation.
Core rules and concepts
- Money works as a medium of exchange, unit of account, store of value, and standard of deferred payment.
- M1 = currency with the public + demand deposits + other deposits with RBI; broader measures add time deposits and post-office deposits.
- Credit creation: total deposits = initial deposit × 1/reserve ratio; credit created = total deposits − initial deposit.
- RBI tools include repo and reverse repo, CRR, SLR, open-market operations, and bank rate.
- Demand-pull inflation comes from excess aggregate demand; cost-push inflation from rising input costs. Inflation hurts creditors and fixed-income earners and helps debtors.
Worked example
A bank receives a primary deposit of ₹1,000 and the reserve ratio is 20%. The credit multiplier is 1/0.20 = 5, so total deposits can reach ₹5,000 and new credit created is ₹4,000. If CRR rises to 25%, the multiplier falls to 4, total deposits fall to ₹4,000, and credit creation falls to ₹3,000. A rise in CRR therefore contracts credit and is used to fight inflation.
Traps that cost marks
Do not confuse CRR with SLR; CRR is held with RBI, SLR in approved assets. Do not treat the multiplier as 1/CRR when leakages such as cash holding are large. Do not say inflation helps creditors. Do not confuse nominal and real interest rates; real rate ≈ nominal rate − inflation.