CBSE Class 12 Macroeconomics Revision Notes Chapter 3 Money and Banking
Money and Banking explains how money supports exchange, savings, payments and credit creation in an economy. In CBSE Class 12 Macroeconomics, this chapter covers money, money demand, money supply, commercial banks, central banks and monetary policy tools in India.
Money and Banking is an important chapter in Class 12 Macroeconomics. It explains why money is needed, how it removes the limitations of barter exchange and how banks help create money through deposits and loans.
This chapter also covers the Reserve Bank of India, measures of money supply, high powered money, CRR, SLR, repo rate, reverse repo rate, bank rate and open market operations. These CBSE Class 12 Macroeconomics Revision Notes Chapter 3 help students revise definitions, formulas, differences and exam-focused points in one place.
Key Takeaways
- Money: A commonly accepted medium of exchange used for buying and selling goods and services.
- Barter exchange: Direct exchange of goods for goods without using money.
- Money supply: Total stock of money held by the public at a point of time.
- Banking system: Commercial banks create credit, while the central bank regulates money supply.
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Money and Banking Class 12 Economics Notes: Chapter Overview
Money and Banking Class 12 Economics Notes explain how money, banks and the central bank work in an economy. The chapter starts with barter exchange and the functions of money, then moves to demand for money, supply of money, measures of money supply and credit creation by commercial banks.
These Class 12 Macroeconomics Chapter 3 Notes also cover the role of the central bank. Students learn how RBI controls money supply through CRR, SLR, bank rate, open market operations, repo rate and reverse repo rate.
| Concept | What Students Revise |
| Money | Meaning, features and functions of money |
| Barter exchange | Difficulties of exchange without money |
| Demand for money | Transaction and speculative motives |
| Supply of money | Currency, deposits and money supply measures |
| Commercial bank | Deposits, loans and credit creation |
| Central bank | RBI functions and monetary control |
| Money multiplier | Link between reserve ratio and deposit creation |
| Policy tools | CRR, SLR, bank rate, OMO, repo and reverse repo |
Meaning of Money in Class 12 Macroeconomics Chapter 3 Notes
Money is anything that is commonly accepted as a medium of exchange. It is used to buy goods, pay for services, repay debts and store purchasing power.
Money has no role in a one-person economy because there is no exchange. It becomes important when people take part in market transactions.
| Feature | Explanation |
| General acceptance | People accept it in exchange for goods and services |
| Medium of exchange | It helps buyers and sellers complete transactions |
| Measure of value | Prices are expressed in money terms |
| Store of value | It can be saved for future use |
| Support for credit | It helps in loans and future payments |
Money reduces the problems of direct exchange and makes the economy more organised.
Barter Exchange and Its Difficulties
Barter exchange means direct exchange of goods and services without using money.
For example, a farmer may exchange rice for clothes. This exchange can happen only if the farmer wants clothes and the cloth seller wants rice at the same time.
| Term | Meaning |
| Barter exchange | Goods exchanged directly for goods |
| Double coincidence of wants | Both parties want each other’s goods at the same time |
| Exchange problem | Matching wants becomes difficult |
Barter exchange becomes difficult in a large economy because people may not easily find someone with matching needs.
Difficulties of Barter Exchange
Money was introduced because barter exchange had several limitations.
| Difficulty | Explanation |
| Lack of double coincidence of wants | Both parties may not need each other’s goods |
| Lack of common measure of value | No standard unit exists to compare values |
| Lack of divisibility | Some goods cannot be divided easily |
| Lack of store of value | Perishable goods cannot be stored for long |
| Lack of deferred payment standard | Future payments become difficult |
| Difficulty in exchange of services | Services cannot always be exchanged directly |
These difficulties make barter unsuitable for a modern economy.
How Money Solves the Problems of Barter Exchange
Money removes the need for direct matching of wants. A seller can sell goods for money and use the same money to buy other goods later.
| Barter Problem | Money’s Solution |
| Double coincidence needed | Money is accepted by all |
| No common value measure | Prices are expressed in money |
| Goods may not be divisible | Money can be divided into smaller units |
| Perishable goods lose value | Money can store value |
| Future payments are difficult | Money acts as standard of deferred payment |
Money makes exchange easier, faster and more reliable.
Functions of Money in Money and Banking Class 12 Notes
Money performs primary, secondary and supporting functions in an economy.
| Function Type | Functions |
| Primary functions | Medium of exchange, measure of value |
| Secondary functions | Store of value, standard of deferred payment, transfer of value |
| Other functions | Basis of credit, liquidity, income distribution, price mechanism |
The primary function of money is to act as a medium of exchange.
Primary and Secondary Functions of Money
Primary functions are the basic functions of money. Secondary functions make money useful beyond immediate exchange.
| Function | Meaning |
| Medium of exchange | Money is used to buy and sell goods and services |
| Measure of value | Money expresses the value of goods and services |
| Store of value | Money can be saved for future use |
| Standard of deferred payment | Future payments can be fixed in money terms |
| Transfer of value | Money transfers purchasing power from one person or place to another |
Money can act as a store of value only when its purchasing power remains reasonably stable.
Money as a Medium of Exchange
Money acts as an intermediary between buyers and sellers. It removes the need for double coincidence of wants.
A person can sell goods for money and then use that money to buy any other good or service. This makes exchange possible even when two people do not directly need each other’s goods.
Money as a Measure of Value
Money works as a unit of account. The value of all goods and services can be expressed in monetary units.
For example, if a pen costs ₹10 and a pencil costs ₹2, one pen is worth five pencils. This makes comparison easier.
Fiat Money, Fiduciary Money and Legal Tender
Money can be classified based on law, trust and value.
| Term | Meaning |
| Fiat money | Money declared legal tender by the government |
| Legal tender | Money that must be accepted for payment of debts |
| Commodity money | Money with intrinsic value, such as gold or silver |
| Fiduciary money | Money accepted on the basis of trust |
Fiat money is not backed by a physical commodity. Its value comes from government authority and public acceptance.
Demand for Money: Transaction and Speculative Motives
Demand for money means the desire to hold money in liquid form.
People demand money because it is the most liquid asset. It can be used immediately for transactions.
| Motive | Meaning |
| Transaction motive | Holding money for regular transactions |
| Speculative motive | Holding money for future investment opportunities |
Demand for money depends on income, value of transactions, price level and interest rate.
Transaction Motive for Demand for Money
Transaction motive means holding money for regular purchases and payments.
| Feature | Explanation |
| Purpose | Day-to-day transactions |
| Related to | Income and value of transactions |
| Relationship with income | Higher income usually increases transaction demand |
| Example | Money kept for food, travel, rent and bills |
People receive income at specific times but spend it regularly. This creates the need to hold money.
Speculative Motive for Demand for Money
Speculative motive means holding money to take advantage of future investment opportunities.
| Feature | Explanation |
| Purpose | To use future asset price changes |
| Related to | Interest rate |
| Relationship with interest rate | Inverse relationship |
| If interest rate rises | Speculative demand for money falls |
| If interest rate falls | Speculative demand for money rises |
People may prefer holding money when they expect better investment options later.
Aggregate Demand for Money
Aggregate demand for money includes transaction demand and speculative demand.
Money Demand = Transaction Demand + Speculative Demand
| Component | Depends On |
| Transaction demand | Income, price level and value of transactions |
| Speculative demand | Market interest rate |
Transaction demand is positively related to income. Speculative demand is inversely related to interest rate.
Supply of Money in Class 12 Economics Chapter 3 Notes
Supply of money means the total stock of money held by the public at a particular point of time.
It includes currency held by the public and deposits held by the public in banks.
| Included in Money Supply | Not Included in Money Supply |
| Currency held by public | Cash held by government |
| Demand deposits with banks | Cash held by banks |
| Other deposits with RBI | Money stock within banking system |
Money supply is a stock variable because it is measured at a point of time.
Money Supply and Its Components
Money supply includes the money available for active use by the public.
| Component | Meaning |
| Currency with public | Notes and coins held by people |
| Demand deposits | Bank deposits withdrawable on demand |
| Other deposits with RBI | Deposits held by certain institutions with RBI |
| Time deposits | Deposits kept for a fixed period |
Cash balances held by the government and banking system are not included because they are not in active circulation.
Measures of Money Supply: M1, M2, M3 and M4
Measures of money supply show different levels of liquidity in the economy.
| Measure | Components |
| M1 | Currency with public + Demand deposits with banks + Other deposits with RBI |
| M2 | M1 + Savings deposits with post office savings banks |
| M3 | M1 + Net time deposits with commercial banks |
| M4 | M3 + Total post office deposits excluding National Savings Certificates |
M1 is the most liquid measure. M3 is widely used as a broad measure of money supply.
Narrow Money and Broad Money
Money supply measures are classified as narrow money and broad money.
| Basis | Narrow Money | Broad Money |
| Measures | M1 and M2 | M3 and M4 |
| Liquidity | More liquid | Less liquid than narrow money |
| Includes time deposits | No | Yes |
| Use | Immediate liquidity analysis | Wider money stock analysis |
Narrow money includes highly liquid money. Broad money includes less liquid deposits too.
Commercial Bank and Its Functions
A commercial bank is a financial institution that accepts deposits from the public and gives loans for investment and other purposes.
Commercial banks work for profit.
| Function | Explanation |
| Accepting deposits | Takes deposits from households and firms |
| Giving loans | Lends money to borrowers |
| Credit creation | Creates deposits through lending |
| Discounting bills | Provides funds against bills of exchange |
| Agency services | Transfers funds and collects payments |
| Utility services | Provides lockers, foreign exchange and traveller cheques |
State Bank of India and Canara Bank are examples of commercial banks.
Functions of Commercial Banks
Commercial bank functions can be grouped into primary functions, agency functions and general utility functions.
| Type | Functions |
| Primary functions | Accepting deposits, giving loans, discounting bills |
| Agency functions | Fund transfer, payment collection, buying and selling securities |
| General utility functions | Locker facility, traveller cheques, foreign exchange services |
Commercial banks connect savers and borrowers.
Central Bank and Its Functions
A central bank is the apex financial institution of a country. In India, the central bank is the Reserve Bank of India.
| Function | Explanation |
| Bank of issue | Issues currency |
| Banker to government | Handles government banking functions |
| Banker’s bank | Holds reserves of commercial banks |
| Lender of last resort | Provides funds to banks in crisis |
| Custodian of foreign exchange reserves | Manages foreign exchange reserves |
| Credit controller | Controls money supply and credit |
The central bank regulates and stabilises the monetary system.
Commercial Bank and Central Bank Difference
Commercial banks and the central bank perform different roles in the banking system.
| Basis | Commercial Bank | Central Bank |
| Meaning | Bank serving public deposits and loans | Apex monetary authority |
| Objective | Profit earning | Economic and monetary stability |
| Currency issue | Cannot issue currency | Issues currency |
| Customers | Public, firms and institutions | Government and commercial banks |
| Credit role | Creates credit | Controls credit |
| Example | SBI, Canara Bank | RBI |
Commercial banks create credit, while the central bank controls credit.
High Powered Money or Reserve Money
High powered money is money created by the central bank and the government.
It includes currency held by the public and cash reserves held by banks.
| Term | Meaning |
| High powered money | Currency with public + bank reserves |
| Also called | Reserve money or monetary base |
| Created by | Central bank and government |
| Importance | Basis for credit creation |
High powered money supports the creation of demand deposits by commercial banks.
Credit Creation by Commercial Banks
Commercial banks create credit by accepting deposits and lending a part of those deposits.
Banks do not keep all deposits as reserves because all depositors do not withdraw money at the same time.
| Step | Process |
| 1 | People deposit money in banks |
| 2 | Banks keep required reserves |
| 3 | Banks lend the remaining amount |
| 4 | Loan amount becomes deposit again |
| 5 | Deposits expand through repeated lending |
This process increases money supply in the banking system.
Balance Sheet of a Commercial Bank
A bank’s balance sheet shows assets and liabilities.
| Assets | Liabilities |
| Reserves | Deposits |
| Loans | Net worth |
Assets = Reserves + Loans
Liabilities = Deposits
Net Worth = Assets − Liabilities
Deposits are liabilities for a bank because the bank must return them to depositors. Loans are assets because they are claims of the bank.
Money Multiplier in Class 12 Macro Economics Revision Notes Chapter 3
Money multiplier shows how much money supply can expand from a given amount of reserves.
Money Multiplier = 1 ÷ Reserve Ratio
If the reserve ratio is 20%, the money multiplier is:
Money Multiplier = 1 ÷ 0.20 = 5
This means reserves of ₹100 can support deposits of ₹500.
Reserve Ratio and Credit Creation
Banks must keep a part of deposits as reserves.
| Term | Meaning |
| Required Reserve Ratio | Percentage of deposits banks must keep as reserves |
| CRR | Cash reserve kept with RBI |
| SLR | Liquid assets maintained by banks |
| Reserve requirement | Limit on how much banks can lend |
A higher reserve ratio reduces credit creation. A lower reserve ratio increases credit creation.
Currency Deposit Ratio and Reserve Deposit Ratio
These ratios affect money supply and credit creation.
| Ratio | Formula | Meaning |
| Currency Deposit Ratio | CDR = Currency held by public ÷ Demand deposits | Shows public preference for cash |
| Reserve Deposit Ratio | RDR = Reserves held by banks ÷ Total deposits | Shows bank reserves as share of deposits |
When people hold more cash, deposits with banks fall. This can reduce credit creation.
CRR and SLR in Money and Banking
CRR and SLR are reserve requirements used to regulate credit.
| Basis | CRR | SLR |
| Full form | Cash Reserve Ratio | Statutory Liquidity Ratio |
| Maintained with | RBI | Bank itself in liquid assets |
| Form | Cash reserve | Cash, gold or approved securities |
| Effect of increase | Reduces bank lending | Reduces bank lending |
| Used by | RBI | RBI regulation |
Both CRR and SLR affect the lending capacity of commercial banks.
RBI Tools to Control Money Supply
The Reserve Bank of India controls money supply through quantitative and qualitative tools.
| Tool Type | Examples |
| Quantitative tools | CRR, SLR, bank rate, open market operations, repo rate, reverse repo rate |
| Qualitative tools | Moral suasion, margin requirement, selective credit control |
Quantitative tools influence the overall volume of credit. Qualitative tools influence the direction or purpose of credit.
Bank Rate and Its Effect on Money Supply
Bank rate is the rate at which RBI gives loans to commercial banks for long-term needs.
| Change in Bank Rate | Effect |
| Increase in bank rate | Borrowing becomes costly, money supply falls |
| Decrease in bank rate | Borrowing becomes cheaper, money supply rises |
Bank rate affects the lending rates of commercial banks.
Open Market Operations
Open market operations refer to buying and selling of government securities by the central bank in the open market.
| RBI Action | Effect on Money Supply |
| RBI buys government securities | Reserves increase, money supply increases |
| RBI sells government securities | Reserves decrease, money supply decreases |
Open market operations are used to manage liquidity in the economy.
Repo Rate and Reverse Repo Rate
Repo and reverse repo are important monetary policy tools.
| Term | Meaning | Effect |
| Repo rate | Rate at which RBI lends money to commercial banks against securities | Affects borrowing cost for banks |
| Reverse repo rate | Rate at which RBI borrows money from commercial banks | Absorbs excess liquidity |
A higher repo rate can reduce borrowing and money supply. A lower repo rate can increase borrowing and liquidity.
Monetary Policy Tools Used by RBI
Monetary policy refers to the policy used by the central bank to control money supply, credit and interest rates.
| Objective | Explanation |
| Control inflation | Reduces excess money supply |
| Regulate liquidity | Manages cash and credit in economy |
| Support growth | Ensures adequate credit availability |
| Stabilise financial system | Maintains confidence in banking system |
RBI uses monetary policy to maintain economic stability.
Lender of Last Resort
The central bank is called the lender of last resort because it provides funds to commercial banks during financial difficulty.
| Situation | Role of RBI |
| Bank faces shortage of reserves | RBI lends funds |
| Public loses confidence in banks | RBI supports banking stability |
| Liquidity crisis occurs | RBI provides emergency support |
This role helps protect the banking system.
Sterilisation by RBI
Sterilisation refers to RBI’s market-based action to neutralise the monetary effect of foreign inflows.
If foreign capital inflows increase liquidity, RBI may sell government securities to absorb excess money.
| Situation | RBI Action |
| Foreign inflows increase money supply | RBI absorbs liquidity |
| Excess liquidity creates inflation risk | RBI sells securities |
| Liquidity falls too much | RBI may inject money |
Sterilisation helps control unwanted changes in money supply.
Money Supply and Interest Rate
Money supply and interest rates are closely related.
| Situation | Likely Effect |
| Money supply increases | Interest rates may fall |
| Money supply decreases | Interest rates may rise |
| Repo rate increases | Bank loans may become costly |
| Repo rate decreases | Bank loans may become cheaper |
Interest rate changes influence borrowing, lending and investment.
Important Formulas from Money and Banking Class 12 Economics Notes
| Concept | Formula |
| M1 | Currency with public + Demand deposits + Other deposits with RBI |
| M2 | M1 + Savings deposits with post office savings banks |
| M3 | M1 + Net time deposits with commercial banks |
| M4 | M3 + Total post office deposits excluding NSC |
| Money Demand | Transaction demand + Speculative demand |
| Currency Deposit Ratio | CDR = Currency ÷ Demand deposits |
| Reserve Deposit Ratio | RDR = Reserves ÷ Deposits |
| Money Multiplier | 1 ÷ Reserve Ratio |
| Assets of bank | Reserves + Loans |
| Net Worth | Assets − Liabilities |
Money and Banking Important Differences
Barter Exchange and Money Economy
| Basis | Barter Exchange | Money Economy |
| Medium | Goods exchanged for goods | Money used for exchange |
| Double coincidence | Required | Not required |
| Value measurement | Difficult | Easy |
| Store of value | Difficult | Easier |
| Deferred payment | Difficult | Possible |
Transaction Demand and Speculative Demand
| Basis | Transaction Demand | Speculative Demand |
| Purpose | Day-to-day transactions | Future investment opportunities |
| Related to | Income and value of transactions | Interest rate |
| Relationship | Positive with income | Inverse with interest rate |
| Nature | Regular need | Asset-holding decision |
Narrow Money and Broad Money
| Basis | Narrow Money | Broad Money |
| Measures | M1, M2 | M3, M4 |
| Liquidity | Higher | Lower |
| Includes time deposits | No | Yes |
| Use | Immediate liquidity | Wider money stock |
CRR and SLR
| Basis | CRR | SLR |
| Full form | Cash Reserve Ratio | Statutory Liquidity Ratio |
| Form | Cash | Cash, gold, approved securities |
| Maintained with | RBI | Bank itself |
| Purpose | Controls bank reserves | Ensures liquidity and safety |
Common Mistakes Students Should Avoid
| Mistake | Correct Understanding |
| Calling barter money-based exchange | Barter means exchange without money |
| Confusing fiat money and commodity money | Fiat money has value by government order |
| Including government cash in money supply | Money supply includes money held by public |
| Treating all deposits as equally liquid | Demand deposits are more liquid than time deposits |
| Mixing CRR and SLR | CRR is cash with RBI, SLR is liquid assets with bank |
| Forgetting inverse relation with interest rate | Speculative demand falls when interest rate rises |
| Calling RBI a commercial bank | RBI is the central bank |
NCERT-Based Exam Points
- Money is the commonly accepted medium of exchange.
- Barter exchange requires double coincidence of wants.
- Money acts as a medium of exchange and unit of account.
- Money can act as a store of value if its purchasing power is stable.
- Demand for money is also called liquidity preference.
- Transaction demand rises with income and value of transactions.
- Speculative demand is inversely related to interest rate.
- Money supply is a stock variable.
- In India, RBI regulates money supply.
- M1 and M2 are narrow money.
- M3 and M4 are broad money.
- Commercial banks accept deposits and give loans.
- Commercial banks create credit through lending.
- Deposits are liabilities for commercial banks.
- Loans are assets for commercial banks.
- High powered money is also called reserve money or monetary base.
- CRR limits the credit creation capacity of banks.
- SLR requires banks to hold liquid assets.
- Money multiplier depends on the reserve ratio.
- A higher reserve ratio reduces money creation.
- RBI is the central bank of India.
- RBI issues currency.
- RBI acts as banker to the government.
- RBI acts as lender of last resort.
- Open market operations affect reserves and money supply.
- Repo and reverse repo operations are major RBI monetary policy tools.
- Bank rate changes influence money supply.
Useful Links for Class 12 Macroeconomics Revision Notes
| Section | Useful Links |
| Revision Notes | CBSE Class 12 Macro Economics Revision Notes |
| Macroeconomics Notes | CBSE Class 12 Macro Economics Revision Notes Chapter 1 |
| Macroeconomics Notes | CBSE Class 12 Macro Economics Revision Notes Chapter 2 |
| Economics Notes | CBSE Class 12 Economics Notes |
| NCERT Solutions | NCERT Solutions Class 12 Macro Economics |
| NCERT Solutions | NCERT Solutions Class 12 Economics |
| Important Questions | Important Questions Class 12 Macro Economics |
| Revision Notes | CBSE Class 12 Revision Notes |
FAQs (Frequently Asked Questions)
The chapter explains how money works as a medium of exchange, unit of account, store of value and standard of deferred payment. It also covers money demand, money supply, commercial banks, credit creation, central bank functions and RBI tools used to control money supply.
Barter exchange is difficult because it needs double coincidence of wants. It also lacks a common measure of value, store of value, divisibility and standard of deferred payment. Money solves these problems by becoming a common medium accepted by buyers and sellers.
Demand for money means the amount of money people want to hold in liquid form. Supply of money means the total stock of money held by the public at a point of time. Demand depends on income, transactions and interest rate, while supply is regulated by the banking system and RBI.
Commercial banks create credit by lending a part of deposits after keeping required reserves. The money multiplier shows how much deposits can expand from a given reserve base. A lower reserve ratio increases the money multiplier, while a higher reserve ratio reduces credit creation.
CRR and SLR reduce or increase banks’ lending capacity. Bank rate and repo rate affect the cost of borrowing from RBI. Open market operations change bank reserves through buying or selling government securities. Together, these tools help RBI control money supply and liquidity.