Page 164 - DECO402_Macro Economics

Unit-17: Money Multiplier and Credit Creation by Commercial Banks

This general belief has been found that there is an intense relation between supply of money and Notes
price level. When there is an increase in supply of money then through increase in demand prices
also increase. Undoubtedly, supply of money has a direct influence on prices but it is difficult to
agree with this opinion of Irving Fisher, the main supporter of Quantity Theory of Money, that there
is a direct and proportionate relation between quantity of money and price level. For example, in
the above given table it is shown that during the period of first plan, there was a fall in price level
whereas money supply increased. During the period of ninth plan, in price level there was an increase
of only 3.9 percent, whereas in supply of money, there was an increase of 14.2 percent. In an under
developed country like India, a large pat of the economy is un-monetized. In this field, all transactions
are done on the basis of exchange of goods. If one part of supply of money is used for monetization
of this field then demand will increase by this but there will be no increase in prices. Hence in under
developed countries like India, if increase in supply of money is used for increasing production and
for monetization of non-monetized areas, then prices will not increase.
Form the above table, it is known that supply of money does have in influence on prices but there is
no special relation between these two. How increase will be there in prices, as a result of increase in
supply of money, this depends on many factors, especially on increase in production in the economy.
According to Prof. B.N. Pandit, almost a time lag of one year is found in increase in supply of money
in India and its influence on prices. During the period of plans, average rate of increase in supply of
money was 14 per cent whereas rate of growth (on increase in national income) was 4.1% and increase
rate (growth rate) of price level had been 6.6%.

17.9 How does Money Get into the Economy?

How does a unit of money get into the economy? It is an important question which a student of
economics should understand. In most countries of the world central bank issues notes and coins.
For a general person, central bank (RBI in India) prints money and introduces it in the economy. But
on which conditions and under what circumstances central bank prints money and introduces it, this
question is not as easy as a general person thinks.
Government, for fulfilling budgetary loss, takes loan from the central bank (RBI) by giving its security.
Central bank, by printing more money, gives loan to the government and government spends this
loan on various developmental and non-developmental works. People may find their income in form
of tax (Lagan), labour, profit and interest, from expense done by the government on various projects.
In this form currency is introduced in the economy.

As per Lipsey and Chrystal, ‘The central bank gets high powered money into the economy
simply by buying securities (usually government debt instruments). It pays for these purchases
with newly issued high powered money."

17.10 Does Supply of Money in the Economy Depend on the Discretion
of the Central Bank?

No, Supply of Money in the economy does not depend on the discretion of the central bank. No doubt
that the central bank (RBI) of the country is officer for issuing the currency of the country. But net
sypply of money does not only depend upon the discretion of the central bank. Nte supply of money
in an economy depends on the nature and will of the below given factors of the economy:-
(i) Central bank of the country (ii) Commercial bank of the country (iii) General Public.
y Deciding the quantity of high power money which does the job of money multiplier, central
banks does determines its supply.

LOVELY PROFESSIONAL UNIVERSITY 157