Money, Banking and Inflation

📘 NDA Economics · ECN04 📑 NDA Level : High Priority

For NDA, know the functions of money, the key RBI tools and their rates, and the two types of inflation. Questions are direct definition-based from NCERT.

📌 NDA Pattern: Functions of money • M1/M2/M3 components • Repo vs Reverse Repo • CRR vs SLR • Demand-pull vs Cost-push inflation • CPI vs WPI

1. Money & Money Supply

Functions of Money: (1) Medium of Exchange • (2) Unit of Account • (3) Store of Value • (4) Standard of Deferred Payment.
M1 (Narrow Money): Currency in circulation + Demand Deposits. Most liquid.
M3 (Broad Money): M1 + Time Deposits. Most commonly tracked by RBI.

2. RBI & Monetary Policy

RBI (Reserve Bank of India): India’s central bank. Est. 1935. HQ: Mumbai. Governor: Sanjay Malhotra (Dec 2024). Functions: issues currency, controls money supply, banker to government, lender of last resort.
Repo Rate (6.25%): RBI lends TO commercial banks. Rise → costlier credit → inflation controlled.
Reverse Repo Rate (3.35%): RBI borrows FROM commercial banks.
CRR (4.0%): Cash banks must keep with RBI; earns no interest. Rise → less lending → money supply falls.
SLR (18.0%): Liquid assets (govt securities, gold) banks must hold. Rise → less to lend.
OMO (Open Market Operations): RBI buys govt securities → injects money (expansionary). Sells → absorbs money (contractionary).

3. Inflation

Demand-Pull Inflation: “Too much money chasing too few goods.” Excess demand pushes prices up. Occurs during boom.
Cost-Push Inflation: Rising production costs (oil, wages) push prices up. Occurs even with low demand (stagflation).
CPI (Consumer Price Index): Retail prices; RBI’s policy target (4% ±2%). Measures cost of living.
WPI (Wholesale Price Index): Producer/wholesale prices. NOT RBI’s target. Ministry of Commerce.
Effects: Debtors benefit; Creditors/savers lose; Fixed income earners suffer.

📝 NDA PYQMoney, Banking & Inflation — NDA Pattern

Q1. Repo Rate is the rate at which: (NDA I 2024)

(a) RBI borrows from commercial banks (b) RBI lends to commercial banks (c) Commercial banks lend to public (d) Government borrows from RBI

Answer: (b) RBI lends TO commercial banks
Repo (Repurchase) Rate = rate at which RBI provides short-term loans to commercial banks against government securities as collateral. When Repo rises, borrowing cost rises, credit contracts. Reverse Repo = RBI borrows FROM banks (banks park surplus with RBI).

Q2. Which inflation is caused by a rise in the cost of production? (NDA II 2023)

(a) Demand-pull inflation (b) Cost-push inflation (c) Galloping inflation (d) Hyperinflation

Answer: (b) Cost-push inflation
Cost-push = supply-side shock. When oil prices spike globally (like 1973 OPEC crisis), production costs rise → firms pass on costs as higher prices → inflation even without excess demand. This can cause stagflation (inflation + unemployment).

Q3. CRR stands for Cash Reserve Ratio. Currently, if CRR is increased by RBI, what happens? (NDA I 2023)

(a) More funds available with banks for lending (b) Banks keep more funds with RBI; money supply falls (c) Interest rates fall (d) Government spending increases

Answer: (b) Banks keep more funds with RBI; money supply falls (contractionary)
CRR = % of total deposits banks must hold as cash with RBI (earns zero interest). CRR up → less money to lend → money supply contracts → useful for inflation control. RBI cut CRR from 4.5% to 4.0% in Dec 2024 to release liquidity.

📝 Rapid Revision — ECN04

🏭 RBI Tools

Repo: 6.25% (RBI lends to banks)
Reverse Repo: 3.35% (RBI borrows from banks)
CRR: 4.0% (cash with RBI; no interest)
SLR: 18.0% (liquid assets)
OMO: buy = expand; sell = contract

📈 Inflation Types

Demand-pull = excess demand (boom phase)
Cost-push = supply shock (oil prices)
CPI = RBI target (4% ±2%); retail prices
WPI = wholesale level; Ministry of Commerce
Debtors benefit; creditors/savers lose

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