Money, Banking and Government Budget
This domain tests money's functions and supply measures, credit creation by commercial banks, central banking tools, and the budget's receipt and deficit structure.
Core rules
- Money serves as medium of exchange, unit of account, store of value and standard of deferred payment; it removes the double coincidence of wants.
- Money supply: M1 = currency with the public + demand deposits + other deposits with the RBI (narrow money); M2 = M1 + savings deposits with post offices; M3 = M1 + net time deposits (broad money); M4 = M3 + total post office deposits.
- Credit creation: banks lend a fraction of deposits; the money multiplier is 1/CRR when there is no currency leakage; total deposits = initial deposit × multiplier.
- Central bank functions: currency issue, banker to government and banks, lender of last resort, custodian of foreign exchange, and credit control through bank rate, repo, CRR, SLR, open market operations and margin requirements.
- Budget receipts are revenue (tax and non-tax) or capital (borrowings, disinvestment). Expenditure is revenue or capital.
- Revenue deficit = revenue expenditure – revenue receipts. Fiscal deficit = total expenditure – total receipts excluding borrowings. Primary deficit = fiscal deficit – interest payments.
Worked example
A fresh deposit of ₹1,000 with CRR = 10% gives a multiplier of 1/0.10 = 10, so total deposits reach ₹10,000 and credit created is ₹9,000. If the RBI raises CRR to 20%, the multiplier falls to 5 and deposits reach only ₹5,000 - a contractionary move that reduces lending capacity.
Traps
Mixing up M1 and M3. Treating government borrowing as a revenue receipt. Saying fiscal deficit equals revenue deficit plus interest payments. Forgetting CRR applies to net demand and time liabilities. Confusing repo (RBI lends) with reverse repo (RBI borrows).