Money Market for CA Foundation
Money and the money market: functions of money, demand for money, measures of money supply, credit creation and the RBI's monetary policy tools.
Business EconomicsPaper 411 MCQs2 lessons2 flashcards3 memory tricks
What you'll learn
- Demand for money and money supply
Explain why people hold money and how money supply is measured in India. - Credit creation and monetary policy
Use the money multiplier and explain the RBI's tools.
Key formulas
| M0 (reserve money) | Currency in circulation + bankers' deposits with RBI + other deposits with RBI |
|---|---|
| M1 | Currency with public + demand deposits + other deposits with RBI |
| M2 | M1 + savings deposits with post offices |
| M3 | M1 + time deposits with banks |
| M4 | M3 + total post office deposits |
| Fisher | MV = PT |
| Simple money multiplier | 1 ÷ CRR |
| Deposits created | Initial deposit × multiplier |
Concepts explained
Demand for money
Keynes said people hold money for transactions, precaution and speculation. The first two depend on income; speculative demand falls as interest rates rise.
What it means
- Transactions and precautionary demand rise with income.
- Speculative demand is inversely related to the interest rate.
- Liquidity trap: at very low interest rates, people hold all extra money.
- Money solves barter's double coincidence of wants.
- FD rates go up
Answer: People hold less idle cash
- Salary doubles
Answer: Transactions demand rises
Related terms
- Functions of money: medium of exchange, measure of value, store of value, deferred payments
- Velocity of money: how often money changes hands
Exam tip: Income → transactions; interest → speculation (inverse).
Money supply measures and the multiplier
The RBI measures money supply from M0 (reserve money) to M1 (narrow) and M3 (broad). Banks create deposits as a multiple of reserves: multiplier = 1/CRR.
What it means
- M0 = currency in circulation + bankers' deposits with RBI + other deposits with RBI.
- M1 = currency with public + demand deposits + other deposits with RBI.
- M3 = M1 + time deposits; M2, M4 add post office deposits.
- Fisher: MV = PT; Cambridge: M = kPY.
- CRR 10%
Answer: 10
- M1 = 56; time deposits = 150
Answer: 206
Related terms
- Credit creation: loans create new deposits
- Velocity: V in MV = PT
Exam tip: M1 narrow, M3 broad; add time deposits to go from M1 to M3.
RBI's monetary policy tools
The RBI controls money and credit through the repo rate, reserve ratios (CRR, SLR) and open market operations.
What it means
- Repo: RBI lends to banks; reverse repo / SDF: banks park funds with RBI.
- CRR: cash kept with RBI; SLR: liquid assets kept by banks.
- OMO: selling securities absorbs money; buying injects it.
- Inflation: raise repo, CRR; sell securities. Slowdown: the opposite.
- Prices rising fast
Answer: Raise repo rate, sell securities
- Demand weak
Answer: Cut repo rate, buy securities
Related terms
- MSF: marginal standing facility: emergency borrowing above repo
- Bank rate: long-term lending rate of RBI
Exam tip: Dearer and scarcer money cools inflation; cheaper and more plentiful money boosts growth.
Memory tricks
Repo rate: RBI lends to banks; reverse repo: banks lend to RBI.
M1 = currency + demand deposits + other deposits; M3 = M1 + time deposits.
Contractionary policy: ↑ repo, ↑ CRR/SLR, OMO sales.
Try 3 CA Foundation-style questions
Q1. The transactions demand for money depends mainly on
- the level of income
- the rate of interest
- the price of gold
- the exchange rate
Show answer
Answer: (1) the level of income
People hold money for day-to-day spending, which rises with income.
Q2. High-powered money (reserve money) consists of
- demand deposits only
- time deposits only
- foreign exchange reserves only
- currency with the public, cash reserves of banks and other deposits with the RBI
Show answer
Answer: (4) currency with the public, cash reserves of banks and other deposits with the RBI
Reserve money (M0) = currency in circulation + bankers' deposits with the RBI + other deposits with the RBI; banks create credit on this base.
Q3. To control inflation, the RBI is most likely to
- cut the repo rate
- buy securities in the open market
- raise the repo rate and sell securities in the open market
- reduce the CRR
Show answer
Answer: (3) raise the repo rate and sell securities in the open market
Tight money policy: higher repo rate, higher CRR, and selling government securities (OMO) all reduce money supply.
Practise all 11 questions Free · explanations for every option · see where you go wrong