Money and Banking

Why this chapter matters for UPSC: "Money and Banking" is Chapter 3 of NCERT's Introductory Macroeconomics (Reprint 2026-27). It explains why people hold money, how commercial banks create it, and how the Reserve Bank of India (RBI) controls it. Every GS3 question on monetary policy, inflation control or liquidity rests on three ideas from this chapter: the demand for money, the money multiplier, and the RBI's tools. This page follows NCERT's order, works every NCERT example, and sets India's current rates and money figures beside the book, each with its date and source.

🧠 First Principles — Read This First

Money removes the double coincidence of wants. Under barter, a person with surplus rice must find someone who has clothing to spare and wants rice. Money is the intermediate good both sides accept. NCERT gives it three functions: medium of exchange, unit of account and store of value. The third works only if prices are stable.

People hold money for two reasons. They need it for transactions, so the demand for money rises with income and the price level. They also hold it instead of bonds when they expect interest rates to rise and bond prices to fall, so the demand for money falls as the interest rate rises. At a very low interest rate everyone expects rates to rise, holds money rather than bonds, and extra money cannot push the rate lower: the liquidity trap.

Banks create money by lending, and reserves limit how much. A bank keeps a fraction of its deposits as reserves and lends the rest; each loan becomes a new deposit. With a reserve ratio of 20 per cent, Rs 100 of reserves supports Rs 500 of deposits: a money multiplier of 5. The RBI controls the base (high-powered money), the reserve ratio and the price at which banks can borrow reserves. That is the whole of monetary control in one sentence.

PART 1 — Quick Reference

The Chapter at a Glance

India's Money and Monetary Policy, Dated (record, not NCERT)

NCERT describes the RBI's tools in general terms. The current settings and figures are below, each from the RBI's own release. Rates are as on 5 October 2026.

PART 2 — Concepts & Narrative

Opening: Why Money Exists

NCERT opens with a definition: "Money is the commonly accepted medium of exchange." In an economy of one person, or of a family on an isolated island that does not trade, money has no function. Once several people trade through the market, it becomes the instrument that makes exchange easy.

Exchange without money is barter, and it presumes "the rather improbable double coincidence of wants". NCERT's example is a woman with surplus rice who wants clothing: she must find someone with surplus clothing who wants rice. As the number of people grows, these search costs "may become prohibitive". An intermediate good that both parties accept removes the problem. That good is money.

3.1 Functions of Money

NCERT names three functions (PDF pp. 1-2).

1. Medium of exchange. "The first and foremost role of money". In a large economy, barter fails because of the cost of finding the right trading partner.
2. Unit of account. The value of every good can be stated in rupees. A wristwatch priced at Rs 500 exchanges for 500 units of money. With a pencil at Rs 2 and a pen at Rs 10, one pen is worth 10 ÷ 2 = 5 pencils, and one rupee is worth 0.5 pencil or 0.1 pen. When the general price level rises, a rupee buys less of every good: NCERT calls this "a deterioration in the purchasing power of money".
3. Store of value. Surplus rice is perishable and needs storage space; money is not perishable, costs little to store and is accepted by anyone at any time. But "to perform this function well, the value of money must be sufficiently stable". Gold, land, houses and bonds can also store value, but they are not easily exchanged for other goods and are not universally accepted.

Beside the book (arithmetic, not NCERT): without a unit of account, an economy with n goods needs a separate price for every pair of goods, n(n − 1)/2 in all. With 1,000 goods that is 4,99,500 prices; with money it is 1,000. Some textbooks add a fourth function, standard of deferred payment; this edition of NCERT does not list it.

The cashless economy. NCERT describes a cashless society as one where transactions happen "through the transfer of digital information" rather than physical notes and coins. It names Jan Dhan accounts, Aadhaar-enabled payment systems, e-wallets and the National Financial Switch as steps towards it, and says financial inclusion "is seen as a realistic dream because of mobile and smart phone penetration across the country". Dated record: the RBI began pilots of its own digital currency, the e₹, for wholesale use on 1 November 2022 and for retail use on 1 December 2022.

3.2 Demand for Money and Supply of Money

3.2.1 Demand for Money

The demand for money depends on two things (PDF p. 2).

• Income. Money is needed for transactions, and the value of transactions depends on income. "A rise in income will lead to rise in demand for money."
• The rate of interest. Holding money means holding fewer interest-earning deposits. So "at higher interest rates, money demanded comes down".

Box 3.1 later builds these two ideas into the transaction motive and the speculative motive.

3.2.2 Supply of Money

In a modern economy, money is cash plus bank deposits. It is created by two kinds of institutions: the central bank and the commercial banks (PDF p. 3).

The central bank. "India got its central bank in 1935", the Reserve Bank of India. NCERT lists its functions: it issues the currency; it controls the money supply through the bank rate, open market operations and reserve ratios; it is banker to the government; it is custodian of the foreign exchange reserves; and it is a bank to the banking system. For money supply, the key function is issuing currency. Currency held by the public or by commercial banks is called high-powered money, reserve money or the monetary base, because it is the basis for credit creation.

Dated record (RBI's own account): the RBI "was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934". Its Central Office was first in Kolkata and moved permanently to Mumbai in 1937. Originally privately owned, it has been fully owned by the Government of India since nationalisation in 1949. Its Preamble sets out its job: "to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth."

Commercial banks. They accept deposits from the public and lend part of the funds to borrowers. They pay depositors a lower interest rate than they charge borrowers. The difference, the spread, is the bank's profit.

Lala the goldsmith. Villagers use gold as money and leave it with Lala for safe-keeping. He gives them paper receipts and charges a small fee. Over time the receipts circulate as money: people pay for wheat or shoes with Lala's receipts.

• Lala holds 100 kg of gold and has issued receipts for 100 kg.
• Ramu asks for a loan of 25 kg. The gold already has owners, but Lala reasons that not all depositors will come for their gold at once, so he lends it and charges interest.
• Ramu pays Ali with the 25 kg; Ali deposits it with Lala and receives a receipt.
• Receipts acting as money now total 125 kg. "It seems that Lala has created money out of thin air!"

"The modern banking system works precisely the way Lala behaves in this example." Banks lend because not all depositors withdraw at once. But a bank must keep enough funds to repay any depositor on demand, because depositors keep their money in a bank only if they are confident of getting it back.

3.3 Money Creation by Banking System

When a bank lends, a new deposit opens in the borrower's name, so money supply becomes old deposits plus the new deposit (plus currency). NCERT uses a one-bank economy and its balance sheet (PDF pp. 4-7).

• Assets = Reserves + Loans. Reserves are the bank's cash and its deposits with the RBI.
• Liabilities = Deposits.
• Net Worth = Assets – Liabilities, recorded on the liabilities side so that the two sides balance.

3.3.1 Balance Sheet of a Fictional Bank (Table 3.1)

Ms Fernandes deposits Rs 100, and the bank keeps the whole amount with the RBI as reserves.

With no currency in circulation, money supply is M1 = Currency + Deposits = 0 + 100 = Rs 100.

3.3.2 Limits to Credit Creation and the Money Multiplier

Mr Mathew wants a loan of Rs 500. If the bank lends it and he deposits it in the same bank, deposits and money supply rise. Can banks create money without limit? No: the RBI requires every bank to keep a percentage of its deposits as reserves, so that no bank is over-lending.

• Cash Reserve Ratio (CRR): the percentage of deposits a bank must keep as cash reserves. NCERT's definition says "with the bank"; the reserve is in fact kept with the RBI, as NCERT's own example shows (Ms Fernandes's deposit goes to the RBI). The RBI's directions refer to the balance a bank must maintain with the Reserve Bank under section 42 of the RBI Act.
• Statutory Liquidity Ratio (SLR): reserves banks must also keep in liquid form.

NCERT's worked example. Leela deposits Rs 100; the reserve ratio is 20 per cent.

1. The bank must keep Rs 20, so it can lend Rs 80. It lends Rs 80 to Jaspal Kaur, which returns as a deposit: deposits are now Rs 180.
2. Required reserves are 20 per cent of 180 = Rs 36. The bank still holds Rs 100 of cash, so it can lend 100 − 36 = Rs 64, to Junaid. That too comes back as a deposit.
3. The process repeats until required reserves equal the Rs 100 the bank holds. That happens when deposits reach Rs 500, because 20 per cent of 500 = 100.

Table 3.2: Money Multiplier Process

Table 3.3: Balance Sheet of the Bank (final)

Money supply rises from Rs 100 to Rs 500 (M1 = 0 + 500). The bank cannot lend beyond Rs 400: "Hence, requirement of reserves acts as a limit to money creation." The money multiplier is 1 ÷ reserve ratio = 1 ÷ 0.2 = 5, so reserves of Rs 100 create deposits of 5 × 100 = Rs 500.

Why a geometric series (Appendix 3.1). Each round adds 80 per cent of the previous round's new deposit: 100 + 80 + 64 + … = 100 × (1 + 0.8 + 0.8² + …). NCERT's appendix shows that a + ar + ar² + … = a ÷ (1 − r) when 0 < r < 1. Here a = 100 and r = 0.8, so the total is 100 ÷ 0.2 = 500.

What determines the multiplier in practice. NCERT's example assumes no one holds currency and banks keep no reserves beyond the minimum. Its Key Concepts list two ratios that relax these assumptions: the currency-deposit ratio (currency held by the public ÷ deposits) and the reserve-deposit ratio (bank reserves ÷ deposits). Write money supply as M = CU + DD and high-powered money as H = CU + R. Dividing both by DD gives (algebra, not NCERT's text):

Money multiplier = M ÷ H = (1 + cdr) ÷ (cdr + rdr)

With cdr = 0 and rdr = 0.2 this gives NCERT's 5. A higher currency-deposit ratio or higher reserves lowers it, because currency held by the public does not come back to banks as deposits.

Dated record: India's CRR is 3 per cent (since the fortnight beginning 29 November 2025), so NCERT's formula alone would give 1 ÷ 0.03 ≈ 33. The measured ratio is far lower: M3 ÷ M0 was 6.21 on 31 December 2025 (5.70 a year earlier; 6.0 when adjusted for the SDF), according to the Economic Survey 2025-26. One reason is visible in the RBI's money data: on 15 September 2026, currency with the public was ₹42.10 lakh crore, about 13 per cent of M3 (derived from the WSS figures in PART 1).

3.4 Policy Tools to Control Money Supply

The RBI is the only institution that can issue currency notes. When banks need funds to create more credit, they can borrow in the market or from the RBI, which stands ready to lend to banks at all times. This makes the central bank the lender of last resort (PDF pp. 7-8).

NCERT divides the RBI's tools into two kinds.

• Quantitative tools change the amount of money: the CRR, the bank rate and open market operations.
• Qualitative tools persuade banks to encourage or discourage lending: moral suasion, margin requirements and similar measures.

Changing the reserve ratio. If the RBI raises the reserve ratio from 20 to 25 per cent, Rs 100 of reserves supports deposits of only Rs 400 (multiplier 4), and the banks can lend only Rs 300 instead of Rs 400. They must call back some loans, and money supply falls. (NCERT's sentence says Rs 100 of reserves "could support deposits of Rs 400" in the earlier case; its own Table 3.3 shows deposits of Rs 500 and loans of Rs 400.)

Open market operations (OMOs). The RBI buys and sells government bonds in the open market on the Government's behalf. When it buys a bond, it pays by cheque, which adds to banks' reserves and raises money supply; when it sells, reserves and money supply fall. There are two kinds:

• Outright OMOs are permanent: the RBI buys (or sells) with no promise to reverse the deal.
• Repo operations are temporary. In a repurchase agreement (repo), the RBI buys a security with an agreed date and price for selling it back: it is lending money, and the interest rate is the repo rate. In a reverse repo, the RBI sells a security with an agreed date and price for buying it back: it is absorbing money, at the reverse repo rate. The RBI runs these at overnight, 7-day, 14-day and other maturities, and they have "now become the main tool of monetary policy of the Reserve Bank of India".

Bank Rate. The rate at which the RBI lends to commercial banks. Raising it makes bank borrowing dearer, reduces banks' reserves and lowers money supply; cutting it does the opposite.

Box 3.1: Demand and Supply for Money, a Detailed Discussion

The transaction motive

People are paid at intervals but spend continuously (PDF pp. 8-10).

• One person. You earn Rs 100 on the first day of the month and spend it evenly. Your balance falls from Rs 100 to 0, so your average holding is (100 + 0) ÷ 2 = Rs 50: half your monthly income, or half your monthly transactions.
• Two-person economy. A firm pays a worker Rs 100 at the start of each month; the worker spends it all on the firm's output. Each holds Rs 50 on average, so the economy's transaction demand is Rs 100. Monthly transactions are Rs 200 (output worth Rs 100 sold to the worker, the worker's services worth Rs 100 sold to the firm).

So transaction demand is a fraction of transactions: MdT = k.T (3.1), where k is a positive fraction. Each rupee here changes hands twice a month, so the velocity of circulation is 2, the inverse of k = ½. Rewriting: v.MdT = T (3.2), with v = 1/k. Money demand is a stock; transactions, and money times velocity, are flows.

Total transactions include intermediate goods and so exceed nominal GDP, but the two move together. NCERT therefore writes MdT = kPY (3.3), where Y is real GDP and P is the price level (the GDP deflator): transaction demand rises with real income and with the price level.

The speculative motive

Wealth can be held as money or as "bonds" (NCERT's name for all other assets). NCERT's bond: a firm borrows Rs 100 by promising Rs 10 after one year and Rs 110 (Rs 10 plus the Rs 100 principal) after two years. Face value Rs 100; maturity two years; coupon rate 10 per cent.

• At a market interest rate of 5 per cent, the present value of the bond is 10 ÷ 1.05 + 110 ÷ 1.05², about Rs 109.29 (NCERT's rounding of 109.297). A bond sold at Rs 100 is a bargain, so buyers bid its price up to its present value. In equilibrium a bond's price equals its present value.
• If the rate rises to 6 per cent, the same bond is worth 10 ÷ 1.06 + 110 ÷ 1.06² ≈ Rs 107.33.

So "the price of a bond is inversely related to the market rate of interest". If you expect interest rates to rise, you expect bond prices to fall and a capital loss, so you sell bonds and hold money. When the rate is high, people expect it to fall and bond prices to rise (a capital gain), so they hold bonds and little money. Speculative demand is therefore inversely related to the interest rate: MdS = (rmax − r) ÷ (r − rmin) (3.4).

The liquidity trap

Total demand for money is the sum of the two motives:

Md = MdT + MdS = kPY + (rmax − r) ÷ (r − rmin) (3.5)

The first term rises with real GDP and the price level; the second falls as the interest rate rises.

The supply of money: notes, coins and deposits

In India, currency notes are issued by the RBI and coins by the Government of India (PDF pp. 12-13). Deposits in savings and current accounts are also money, because cheques drawn on them settle transactions. (So when NCERT says on p. 7 that the RBI "is the only institution which can issue currency", read it as notes.)

Legal Definitions: Narrow and Broad Money

Money supply is a stock: the total money held by the public at a point of time. "RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4" (PDF p. 13).

"Net" means only the public's deposits count; deposits one bank holds in another are excluded. The measures run in decreasing order of liquidity: "M1 is most liquid and easiest for transactions whereas M4 is least liquid of all." And "M3 is the most commonly used measure of money supply. It is also known as aggregate monetary resources".

What RBI's data show today (record). The RBI's Weekly Statistical Supplement publishes M3 with four components: currency with the public, demand deposits with banks, time deposits with banks, and "other" deposits with the RBI. The last item is not in NCERT's M1 = CU + DD. On 15 September 2026, M3 was ₹330.67 lakh crore, and time deposits alone were ₹252.42 lakh crore, about three-quarters of it. NCERT's own Appendix 3.2 makes the same point: the gap between M1 and M3 "is attributable to the time deposits held by commercial banks".

High-powered money is not a subset of M1. H (reserve money, M0) is currency in circulation plus bankers' deposits with the RBI plus other deposits with the RBI; these are exactly the columns of NCERT's Table 3.5. Banks' deposits with the RBI are in H but not in M1, and demand deposits are in M1 but not in H. The money multiplier connects them; it is not a ranking of liquidity.

Box 3.2: Demonetisation

In November 2016 the Government of India withdrew the legal-tender status of the old Rs 500 and Rs 1000 notes, "to tackle the problem of corruption, black money, terrorism and circulation of fake currency in the economy" (PDF p. 14). New Rs 500 and Rs 2000 notes were issued.

• The public could deposit old notes in bank accounts until 31 December 2016 without any declaration, and with the RBI until 31 March 2017 with a declaration.
• To avoid a cash crunch, each person could exchange Rs 4,000 of old notes a day for new ones. Until 12 December 2016, old notes were accepted at petrol pumps, government hospitals and for government dues such as taxes and power bills.
• Costs (NCERT): long queues at banks and ATMs; the shortage of currency hurt economic activity until normalcy returned.
• Gains (NCERT): better tax compliance, as more people came into the tax net; savings moved into the formal financial system, giving banks more funds to lend at lower rates; a shift from cash to electronic payments.

Dated record: NCERT's own Table 3.5 shows the effect on currency: currency in circulation fell from ₹16,63,463 crore in 2015-16 to ₹13,35,266 crore in 2016-17. The Rs 2000 note introduced in 2016 is itself being withdrawn: the RBI announced its withdrawal from circulation on 19 May 2023, said the notes "will continue to be legal tender", and noted that printing had stopped in 2018-19.

Appendix Tables 3.4 and 3.5 (excerpts)

Table 3.4: Changes in M1 and M3 over time (₹ crore). Source as printed: RBI, Handbook of Statistics on the Indian Economy 2024-25.

The table's title says "(2023-24)" but its rows run to 2024-25.

Table 3.5: Components of the monetary base (₹ crore), selected rows. Source as printed: RBI, Handbook of Statistics on the Indian Economy 2024-25.

NCERT titles it "Sources of Change in Monetary Base", but the columns are the components of the base (and of currency), not its sources. The 2016-17 figure for currency with the public is printed as 124124; currency in circulation minus cash with banks gives 12,64,124.

NCERT's Summary

Barter "suffers from lack of double coincidence of wants"; money solves this as a commonly accepted medium of exchange. People hold money for two motives, transaction and speculative. Money supply is currency plus demand and time deposits, classified as narrow or broad by decreasing liquidity. The RBI is India's monetary authority: it regulates money supply "by controlling the stock of high powered money, the bank rate and reserve requirements of the commercial banks", and "it also sterilises the money supply in the economy against external shocks".

PART 3 — UPSC Integration

Three Frameworks

1. Money supply = multiplier × base. Every RBI tool works on one of three things: the base (OMOs add or drain reserves), the multiplier (the CRR, and the public's choice between currency and deposits) or the price of reserves (the repo, SDF and MSF rates). Classify any measure in a question into one of the three, then trace it to deposits and credit.

2. Two motives, one curve. Transaction demand rises with income and prices (kPY); speculative demand falls as the interest rate rises, because bond prices move inversely to rates. Put together, money demand slopes down against the interest rate and turns flat at rmin: the liquidity trap, where adding money does not lower the rate.

3. A rate has a date. Policy rates change at every MPC meeting. Cite the rate with the resolution that set it ("repo 5.25 per cent, held on 5 August 2026"), and say whether a figure is a policy setting (repo, CRR) or a measured outcome (M3, the multiplier of 6.21).

Confused Pairs

Exam Strategy

• Prelims: NCERT's worked numbers (Lala 100 to 125 kg; Rs 100 to Rs 500 at 20 per cent; Rs 300 of loans at 25 per cent; bond Rs 109.29 and Rs 107.33); the M1-M4 definitions and which are narrow or broad; legal tender versus fiat money; repo versus reverse repo; outright OMO versus repo. For current rates, use the latest MPC resolution and check its date: the next meeting is 5 to 7 October 2026.
• Mains: for monetary transmission or liquidity questions, start from money supply = multiplier × base, place each tool (OMO, CRR, repo, SDF, MSF) in it, and give the dated corridor. For demonetisation, use NCERT's two-sided assessment and the currency data in its own Table 3.5.
• Numericals: multiplier = 1 ÷ reserve ratio in NCERT's model; present value = sum of each payment ÷ (1 + r)^t; average transaction balance = half of a payment spent evenly.

Practice Questions

Prelims (UPSC-pattern, not past papers)

1. In NCERT's story, Lala holds 100 kg of gold and has issued receipts for 100 kg. He lends 25 kg to Ramu, who pays Ali, who deposits it with Lala for a receipt. Receipts acting as money now amount to: (a) 75 kg (b) 100 kg (c) 125 kg (d) 150 kg Answer: (c). The 25 kg loan returns as a new deposit, so receipts rise from 100 to 125 kg.

2. A single bank receives a deposit of Rs 100; the reserve ratio is 20 per cent and no one holds currency. When the process ends, total deposits and total loans are: (a) Rs 500 and Rs 400 (b) Rs 500 and Rs 500 (c) Rs 400 and Rs 300 (d) Rs 120 and Rs 100 Answer: (a). Required reserves equal Rs 100 when deposits are Rs 500; loans are 500 − 100 = Rs 400 (NCERT Table 3.3).

3. A two-year bond with a face value of Rs 100 pays Rs 10 after one year and Rs 110 after two. If the market rate of interest rises from 5 to 6 per cent, its price: (a) rises from about Rs 107.33 to Rs 109.29 (b) falls from about Rs 109.29 to Rs 107.33 (c) stays at Rs 100 (d) falls from Rs 110 to Rs 106 Answer: (b). Bond prices move inversely with the interest rate.

4. Consider the following statements about NCERT's speculative demand for money:

   1. At the minimum rate of interest, rmin, speculative demand for money is infinite.
   2. At the maximum rate, rmax, everyone expects the interest rate to rise.
   3. In a liquidity trap, injecting more money lowers the interest rate further.

   Which of the statements given above is/are correct? (a) 1 only (b) 1 and 2 only (c) 2 and 3 only (d) 1, 2 and 3 Answer: (a). At rmax everyone expects the rate to fall (statement 2 is wrong); in the trap extra money is held without lowering the rate (statement 3 is wrong).

5. With reference to NCERT's measures of money supply, consider the following statements:

   1. M1 and M2 are known as narrow money.
   2. M3 is also known as aggregate monetary resources.
   3. M4 is the most liquid measure.

   Which of the statements given above are correct? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 Answer: (a). M1 is the most liquid; M4 is the least.

6. Which one of the following is not legal tender in India? (a) A ₹500 note (b) A ₹10 coin (c) A cheque drawn on a savings account (d) A ₹2,000 note Answer: (c). A cheque can be refused, so demand deposits are not legal tender (NCERT). The ₹2,000 note, though withdrawn from circulation, continues to be legal tender (RBI, 19 May 2023).

7. Consider the following statements about RBI's rates as on 5 October 2026:

   1. The Standing Deposit Facility rate is 25 basis points below the policy repo rate.
   2. The Bank Rate is the same as the policy repo rate.
   3. Under the Marginal Standing Facility, banks can borrow up to 2 per cent of their NDTL.

   Which of the statements given above are correct? (a) 1 and 2 only (b) 1 and 3 only (c) 2 and 3 only (d) 1, 2 and 3 Answer: (b). SDF 5.00 vs repo 5.25; the Bank Rate (5.50) equals the MSF rate, not the repo rate.

8. Consider the following statements about the Monetary Policy Committee under section 45ZB of the RBI Act, 1934:

   1. It includes two Deputy Governors of the RBI.
   2. Three of its six members are appointed by the Central Government.
   3. In the event of a tie, the Governor has a second or casting vote.

   Which of the statements given above are correct? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 Answer: (b). The RBI side is the Governor, the Deputy Governor in charge of monetary policy, and one RBI officer nominated by the Central Board.

NCERT Exercises 1-11 (worked answers)

1. Barter and its drawbacks. Barter is exchange of goods without money. It needs a double coincidence of wants, and search costs rise with the number of traders; it has no common unit of account, so every pair of goods needs its own price; and it is a poor store of value, because goods such as rice perish and take space to store.
2. Functions of money. Medium of exchange (removes the double coincidence of wants); unit of account (all prices in one unit, so relative prices are easy: one pen = 5 pencils); store of value (money does not perish and is accepted by anyone, provided prices are stable).
3. Transaction demand. The money people hold to make transactions. It is a fraction k of the value of transactions T over a period: MdT = kT, or v.MdT = T with velocity v = 1/k. In the two-person economy, Rs 100 of money finances Rs 200 of monthly transactions, so k = ½ and v = 2. Since transactions move with nominal GDP, MdT = kPY.
4. Alternative definitions of money supply. M1 = CU + DD; M2 = M1 + savings deposits with post office savings banks; M3 = M1 + net time deposits of commercial banks; M4 = M3 + total deposits with post office savings organisations (excluding NSCs). M1 and M2 are narrow money, M3 and M4 broad money.
5. Legal tender and fiat money. Legal tender is money that cannot be refused in settlement of a transaction: notes and coins. Fiat money has value by government order, not intrinsic worth: notes and coins are fiat money. Demand deposits are money but not legal tender.
6. High-powered money. Currency issued by the central bank and held by the public or by the commercial banks (with banks' deposits at the RBI): reserve money, or the monetary base. It is the base on which banks create credit.
7. Functions of a commercial bank. It accepts deposits; lends a part of them, keeping reserves to repay depositors on demand; earns the spread between lending and deposit rates; and, through lending, creates money (credit creation).
8. Money multiplier and its determinants. The ratio of total money supply (deposits, in NCERT's example) to reserves or high-powered money. In NCERT's model it is 1 ÷ reserve ratio = 5 at 20 per cent. It is lower when the RBI raises the reserve ratio, when banks hold excess reserves, and when the public holds more currency: in general, (1 + cdr) ÷ (cdr + rdr).
9. Instruments of monetary policy. Quantitative: reserve ratios (CRR, SLR), the bank rate, and open market operations (outright, and repo and reverse repo). Qualitative: moral suasion and margin requirements. (Today these work through the LAF corridor of SDF, repo and MSF rates; see PART 2.)
10. Is a commercial bank a creator of money? Yes. As in Lala's story, a bank lends part of its deposits; the loan returns as a new deposit, which is money. With a 20 per cent reserve ratio, Rs 100 of reserves becomes Rs 500 of deposits. The creation is limited by the reserve ratio and by how much the public holds as currency.
11. Lender of last resort. The RBI stands ready to lend to banks at all times when they need funds. This role is called lender of last resort.

📦 Revision Capsule

Sources

• NCERT, Introductory Macroeconomics (Class XII), ch. 3 "Money and Banking", Reprint 2026-27: ncert.nic.in PDF.
• RBI, Resolution of the Monetary Policy Committee, 3-5 August 2026: rbi.org.in; Minutes of the MPC meeting (members and votes), 19 August 2026: rbi.org.in.
• RBI, MPC resolutions of 7 February 2025 (prid 59692), 9 April 2025 (60176), 6 June 2025 (60604), 5 December 2025 (61749), 6 February 2026 (62169), 8 April 2026 (62514) and 5 June 2026 (62863).
• RBI, Governor's Statement, 6 June 2025 (CRR cut in four tranches): rbi.org.in.
• RBI, Reserve Bank of India (Commercial Banks – Cash Reserve Ratio and Statutory Liquidity Ratio) Directions, 2025, 28 November 2025, updated 25 August 2026 (paras 9, 25, 26): rbi.org.in.
• RBI, circular on the SLR glide path, 5 December 2018: rbi.org.in; Marginal Standing Facility scheme notification, 9 May 2011: rbi.org.in.
• RBI, Monetary Policy Committee overview (s. 45ZA and 45ZB, inflation target reviews of 2021 and 25 March 2026, casting vote): rbi.org.in; Minutes of the first MPC meeting, 3-4 October 2016: rbi.org.in.
• RBI, home page, current rates (fetched 5 October 2026; site last updated 3 October 2026): rbi.org.in.
• RBI, About Us (establishment, Central Office, nationalisation, Preamble): rbi.org.in.
• RBI, Weekly Statistical Supplement extract, 2 October 2026 (Table 6, money stock on 15 September 2026; reserves, week ended 25 September 2026): rbi.org.in.
• Ministry of Finance, Economic Survey 2025-26, ch. 3 "Monetary Management and Financial Intermediation: Refining the Regulatory Touch", para 3.14: indiabudget.gov.in PDF.
• RBI, press release on the withdrawal of ₹2000 banknotes from circulation, 19 May 2023: rbi.org.in.
• RBI, digital rupee pilots: wholesale, 31 October 2022 (prid 54616); retail, 29 November 2022 (prid 54773).