Money and Interest Rate Module 4

Questions and Answers

What components are included in M1, the narrow money measure?

Currency, demand deposits, total deposits with post office

Currency with the public, demand deposits, other deposits with RBI (correct)

Currency with the public, demand deposits, savings deposits

Currency with the public, time deposits, savings deposits

Why are savings deposits with post office savings banks considered less liquid than demand deposits?

They are not accepted as a medium of exchange.

They cannot be withdrawn immediately.

They are not chequable accounts. (correct)

They have higher interest rates.

Which of the following best describes the liquidity of M1 in the context of money supply?

It varies based on economic conditions.

It is the least liquid measure of money supply.

It is the most liquid measure of money supply. (correct)

It has medium liquidity.

What is the correct formula for calculating M2?

M2 = M1 + Savings deposits with post office Signup and view all the answers

Which of the following institutions is excluded from calculating other deposits in M1?

Public sector banks Signup and view all the answers

According to the Keynesian liquidity preference theory, what motive is NOT a reason for holding money?

Investment motive Signup and view all the answers

What defines high powered money?

Monetary base which includes currency and reserves Signup and view all the answers

Define one of the key components of the money supply that pertains to the stock of money held by the public.

Demand deposits Signup and view all the answers

What primarily increases the velocity of money circulation?

A higher number of transactions Signup and view all the answers

How do credit facilities influence the velocity of money?

They regulate cash flow available for spending Signup and view all the answers

What effect does inflation have on the value of money?

Inflation reduces the value of money Signup and view all the answers

What is indicated by the money multiplier in the money supply equation?

It shows how money supply expands due to high-powered money Signup and view all the answers

Which of the following is a factor that increases the frequency of consumer spending?

Regular pay and income stability Signup and view all the answers

What does the equation M = kD + D represent?

Total currency supply in the economy Signup and view all the answers

How does convenience in payment methods affect the velocity of money?

It facilitates increased spending behavior Signup and view all the answers

What role do economic cycles play in affecting the value of money?

They can impact money's value through changes in demand and supply dynamics Signup and view all the answers

What constitutes M3 in the context of money supply?

M1 + Time deposits with the banks Signup and view all the answers

Which formula best describes M4?

M3 + Total Deposits with Post Office Signup and view all the answers

What does NM1 encompass in the new monetary aggregates?

Currency with the public + Current deposits + Demand liabilities of savings deposits Signup and view all the answers

What elements are included in the NM0 monetary base measure?

Currency in circulation + Bankers’ deposits with RBI + Other deposits with RBI Signup and view all the answers

Which of the following correctly identifies NM3?

NM2 + Call/Term funding from Financial Institutions Signup and view all the answers

What is a key characteristic of money supply?

It is a stock concept that reflects the total money available at a given time. Signup and view all the answers

What does NM2 include in its measure?

NM1 + Certificate of deposits + Short-term time deposits Signup and view all the answers

Which of the following is a role of the RBI in relation to money supply?

It analyzes growth of money supply and its economic effects. Signup and view all the answers

What does the cash-reserve ratio, denoted by r, represent in banking?

The ratio of cash reserves to deposits Signup and view all the answers

Which of the following factors is NOT a determinant of transaction demand for money?

Interest rate fluctuations Signup and view all the answers

How is precautionary demand for money expressed mathematically?

Lp = f(Y) Signup and view all the answers

The speculative demand for money is primarily based on what assumption?

People hold money in anticipation of future investment opportunities Signup and view all the answers

What does the equation m = (1+k)/(r+k) represent in monetary economics?

The money multiplier Signup and view all the answers

Which of the following theories is NOT mentioned as a theory of money demand?

Monetarist theory Signup and view all the answers

What is the primary purpose of transaction demand for money?

For day-to-day expenses Signup and view all the answers

What is the relationship between active cash balance and income?

Active cash balance is determined by changes in income Signup and view all the answers

What happens in a liquidity trap according to Keynes?

Expansion in money supply does not affect interest rates Signup and view all the answers

What does Keynes state is the primary factor determining the rate of interest?

Demand for and supply of money Signup and view all the answers

How is the liquidity preference theory related to people's attitudes toward liquidity?

People prefer cash to meet various motives Signup and view all the answers

Which assets are considered in Keynes's model of a two-asset economy?

Cash and long-term bonds Signup and view all the answers

What describes the supply of money curve according to the content?

It is perfectly inelastic Signup and view all the answers

What role does the rate of interest serve according to liquidity preference theory?

It's a reward for giving up liquidity Signup and view all the answers

At what point is the rate of interest determined according to the liquidity preference theory?

When supply of money meets demand for money Signup and view all the answers

What is a key consequence of liquidity preference as indicated by Keynes?

Ineffective monetary policy during depression Signup and view all the answers

Study Notes

Money and Interest Rate Module - Key Concepts

Money refers to the stock held in spendable form, generally recognized as a means of exchange, measure, and store of value.
Reserve Bank of India (RBI) categorizes money supply into several measures: Narrow Money (M1), Broad Money (M2, M3, M4).

Components and Measures of Money Supply

Narrow Money (M1): Includes currency with the public, demand deposits with banks, and other deposits with the RBI.
Broad Money:
- M2 = M1 + Savings deposits of post office savings banks.
- M3 = M1 + Time deposits with banks.
- M4 = M3 + Total deposits with post office savings organizations.

New Monetary Aggregates

Four monetary aggregates were established by the Working Group on Money Supply (1998), focusing on balance sheet analysis in the banking sector:
- NM0: Monetary Base (Currency in circulation + Bankers' deposits with RBI + Other deposits with RBI).
- NM1: Currency with the public + Current deposits + Demand liabilities portion of savings deposits + Other deposits with RBI.
- NM2: NM1 + Certificates of deposits + Short-term time deposits.
- NM3: NM2 + Long-term time deposits + Call/Term funding from financial institutions.

Characteristics of Money Supply

Money supply is a stock concept distinct from cash reserves held by commercial banks.
Influenced by transaction frequency, consumer behavior, credit facilities, and overall economic conditions.

Money Multiplier

Represents how much the money supply expands due to an increase in high-powered money, expressed as m = M/H.
The currency-deposit ratio influences the multiplier, showcasing the relationship between total money supply and high-powered money.

Demand for Money

Demand for money reflects the desire to hold financial assets in the form of cash or deposits rather than investments.
Determined primarily by liquidity preferences, categorized into three motives:
- Transaction Demand: Necessary for daily expenses, dependent on income levels, prices, and spending habits.
- Precautionary Demand: Reserves for unexpected expenses, reflecting financial stability and income levels.
- Speculative Demand: Money held for future investments, heavily influenced by interest rates and economic conditions.

Keynesian Liquidity Preference Theory

Interest rates are determined by the demand for money and its supply.
The theory operates on two key functions of money: medium of exchange and store of value.
The liquidity trap scenario indicates where increases in money supply do not influence interest rates, rendering monetary policy ineffective during economic depression.

Determinants of Interest Rates

Interest rates balance at the point where money supply matches demand.
Monetary authorities can adjust interest rates through controlling money supply, impacting economic activity and investment levels.

Modern Monetary Theory and Digital Money

Includes recognition of new economic paradigms and the implications of digital currency as part of the evolving monetary landscape.
Encourages understanding of the roles and effects of monetary policy in contemporary economies.

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Description

Explore the intricacies of the money supply, including its components, determinants, and the RBI's measures. Understand demand for money through Keynesian theories and the implications of modern monetary theory. This module delves into the liquidity preferences and the concept of velocity in circulation.