Base money
Standard macroeconomic texts teach about different levels of monetary aggregates. The simplest of these is the base-money stock. Banks accept base money as deposits and lend out a significant portion of it. In exchange, the banks offer the depositors claims to base money. These claims tend to circulate as media of exchange so long as buyers and sellers believe that these claims are redeemable.
Although governments create fiat base money in modern monetary systems, it is simplest to imagine base money as commodity money. During the days of the gold standard, the base-money stock was simply gold money. Gold circulated hand-to-hand in exchanges. It was costly, however, for owners of gold to keep all of their gold in their possession. Gold is heavy and can be stolen. Holders of gold preferred to leave their gold at the local storehouse and carry instead claims to gold. The claims to gold could be used as money while the gold rested in a secure location. Eventually, the storehouses found that lending the gold at interest allowed them to earn profits from these deposits and share a portion of these profits with depositors. Thus, fractional reserve banking was born and, with it, the dynamics of base and credit moneys.
High powered money
High powered money or powerful money refers to that currency that has been issued by the Government and Reserve Bank of India. Some portion of this currency is kept along with the public while rest is kept as funds in Reserve Bank.
H = C + R
Where H = High Powered Money
C = Currency with the public (Paper money + coins)
R = Government and bank deposits with RBI
Thus the sum total of money deposited with the public and the funds of banks is termed as powerful money. It is mainly created by the central bank. Since funds of commercial banks play an important role in the creation of credit, so it is very important to study about funds.
Reserve Fund is of two types:
- Statutory Reserve Funds of banks which is with the central bank (RR), and
- Extra Reserve Fund(ER).
Thus H = C + RR + ER High powered money is also known as secured money (RM) because banks keep with them Reserve Fund(R) and on the bases of this Demand deposits (DD) are created. Since the bases of creation of credit is Reserve Fund (R) and R is obtained as a part of high powered money (H) Security fund so high powered money is termed as Base money.
Components of High Powered Money
- Currency with the public
- Other Deposits with RBI
- Cash with Banks
- Banker’s Deposits with RBI.
Importance of High Powered Money
Base Money: Deposit of Public in a bank and expansion of credit is the base of supply of money. That is why some economists considered it as base money.
Source of Changes: The direction in which change in the high power money takes place is powered to the direction of change in the supply of money. Thus from this point of view High Powered Money is also important.
Money Multiplier: What will be money multiplier (M) is declared in economy on the bases of High Powered Money because supply of money is far more than high power money.
Monetary Control: A Special attention is paid by the central bank of any country on High Powered Money at the time of monetary control. Because, it is a big part of total supply of money in a country.
Quantity theory of money
The concept of the quantity theory of money (QTM) began in the 16th century. As gold and silver inflows from the Americas into Europe were being minted into coins, there was a resulting rise in inflation. This development led economist Henry Thornton in 1802 to assume that more money equals more inflation and that an increase in money supply does not necessarily mean an increase in economic output. Here we look at the assumptions and calculations underlying the QTM, as well as its relationship to monetarism and ways the theory has been challenged.
The quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. According to QTM, if the amount of money in an economy doubles, price levels also double, causing inflation (the percentage rate at which the level of prices is rising in an economy). The consumer, therefore, pays twice as much for the same amount of the good or service.
Another way to understand this theory is to recognize that money is like any other commodity: increases in its supply decrease marginal value (the buying capacity of one unit of currency). So an increase in money supply causes prices to rise (inflation) as they compensate for the decrease in money’s marginal value.
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