Why there is a Demand for Money ?

There are three motives underlying the demand for money i.e.

1. Transaction demand for money
2. Speculative demand for money
3. Precautionary demand for money

Transaction demand : Transaction demand for money means that money is demanded to carry out certain transactions. It is likely to be positively related with income. This is simply because higher the income of an economic agent, higher is the expected volume of economic transaction. To facilitate higher volume of economic transactions, more money is required. However, the transaction demand for money is influenced by the prevailing rates of interest and the expected rate of return on alternative assets like shares. This is because money held in the form of idle cash provides liquidity and facilitates economic transactions but it does not give a positive return. Therefore, the economic agents will be facing a trade-off between the utility they derive from the liquidity of the available cash and the expected return they are forgoing on alternative assets. So, they will try to economize on their money holding, when the expected returns on alternative assets go up.

Speculative demand :  The demand for money arising out of speculative motive is called speculative demand for money. The speculative demand for money depends on people’s expectation of the future interest rate movements. John Maynard Keynes, in laying out speculative reasons for holding money, stressed the choice between money and bonds. If agents expect the future nominal interest rate (the return on bonds) to be lower than the current rate they will then reduce their holdings of money and increase their holdings of bonds. If the future interest rate does fall, then the price of bonds will increase and the agents will have realized a capital gain on the bonds they purchased. This means that the demand for money in any period will depend on both the current nominal interest rate and the expected future interest rate. The speculative demand for money is low when people expect interest rates to fall in future and vice versa.

Precautionary demand for money : The precautionary demand for money arises because of uncertainty regarding future income. For example, one does not know when one would fall sick or have accident or need money for some unforeseen requirement. The money demanded to cover these expenses is called precautionary demand.

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Different Components of Money in India

In general, money consists of coins, paper money and withdrawable bank deposits. Bank deposits are part of money supply because one can write cheques on these accounts and the cheque possesses the essential qualities of money. Moreover, increasingly credit cards and electronic cash are becoming an important component of the payment system at least after the demonetization and promotion of cashless India. Continuing financial innovations are causing widening of the definition of money.

The Reserve Bank of India (RBI) publishes 4 measures of monetary aggregates in India. These measures define money based on progressive liquidity or spendability. 

M1 = Currency held by the public (currency notes and coins) + Demand deposits with the banking system (on current and saving bank accounts) + Other demand deposits with RBI.
M2 = M1 + saving deposits with Post office savings banks.
M3 = M1 + time deposits with the banking system.
M4 = M3 + total deposits with the post office savings organization (excluding National Savings Certificates).

M1 represents the most liquid form of money among the four money stock measures adopted by RBI. As we proceed from M1 to M4, the liquidity gets reduced. In other words, M4 possesses the lowest liquidity among all these measures. The importance of all these four money stock measures varies from the point of view of monetary policy.
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What is the role of Money?

Money plays a number of extremely important roles in a modern economy. Money has three broad roles:

1. It is a medium of exchange
2. It is a measure of value
3. It can be used as a store of wealth

The most obvious role of money is as a medium of exchange. During the early days of human civilization, it was realized that the barter system suffers from the problem of “double coincidence of wants”. This means that a barter system will only work if two persons can be found whose disposable possessions mutually suit each other’s wants. In a country or in an economy, there may be many people wanting a particular good and there may be many people who possess those things wanted, but to allow a barter or a direct exchange of goods to happen, there has to be a double coincidence of wants. For example, to have his food, a hungry tailor will have to find a farmer who needs a shirt. This is unlikely to happen. The second problem with a pure barter system is that it must have a rate of exchange, where each commodity is quoted in terms of every other commodity. This complication can be avoided if any one commodity be chosen, and its ratio of exchange with each other commodity is known. Such a commodity can be used as a unit of account or a numeraire. To overcome these problems of barter, use of a commonly accepted medium of exchange started. This medium also acted as a measure of value. Different civilizations used different commodities as the medium of exchange.

In some African countries, the medium of exchange was decorative metallic objects called Manilla. The Fijians used whales’ teeth for the same purpose. In some parts of India, cowry or sea shells were used as the medium of exchange and measure of value. Such usages of commodities as the medium of exchange and measure of value correspond to what we presently call ‘Money’. By the 19th century, commodity money narrowed down to usages of precious metals like silver and gold. Interestingly, during the World War II, cigarettes emerged as a form of commodity money in prisoner of war (POW) camps. This however limits the amount of money in the economy as it is constrained by the availability of precious metals which are exhaustible resources. Since then we have moved to an era of paper money. The use of paper money has become widespread because it is a convenient medium of exchange, is easy to carry and store and is also a measure of value for the large number of goods and services produced in a modern economy.The value of money stems from the fact that private individuals cannot legally create money. Only designated authorities are allowed to supply money. This limitation in the supply of money ensures that money retains its value. This also means that money can also be viewed as a store of wealth. It is worth pointing out here that modern currencies are not backed by any equivalent gold or silver reserves. Based on a host of macroeconomic factors, the government or the central bank decides the amount of money to be supplied to an economy.

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Measures for controlling Inflation

In my previous posts I explained about the Impact of inflation over macro-economic factors. In this post lets see how can this inflation be controlled. There are broadly two ways of controlling inflation in an economy – Monetary measures and fiscal measures.

The most important and commonly used method to control inflation is monetary policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation. Monetary measures used to control inflation include (i) bank rate policy (ii) cash reserve ratio and (iii) open market operations. Besides these monetary policy steps, the fiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also take some protectionist measures such as banning the export of essential items such as pulses, cereals and oils to support the domestic consumption, encourage imports by lowering duties on import items etc..,

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Impact of Inflation on macroeconomic variables

Inflation is crucial in determining the purchasing value of money. This has its impact in macro level and lets discuss here the impact of inflation over some macro economic factors such as Exchange rate, Export and Import, Interest rate and Unemployment.

Exchange Rate

Persistently higher inflation in a country (say India rupee ₹) relative to the inflation in another country (say US dollar) generally leads to depreciation of a Rupee in India. Depreciation of the currency of India means decrease in the value of the currency of country relative to the currencies of United States. In other words, if India persistently experiences higher inflation than United states, in exchange for the same number of units of Rupee ₹, the residents of India will get fewer units of US dollar $ than before.

Exports and Imports

As stated, relatively higher inflation in a country leads to the depreciation of its currency vis-à-vis that of the country with lower inflation. If the two countries happen to be trading partners, then the commodities produced by the higher inflation country will lose some of their price competitiveness and hence will experience lesser exports to the country with lower inflation. A currency depreciation resulting from relatively higher inflation leads not only to lower exports but also to higher imports.

Interest Rates

When the price level rises, each unit of currency can buy fewer goods and services than before, implying a reduction in the purchasing power of the currency. So, people with surplus funds demand higher interest rates, as they want to protect the returns of their investment against the adverse impact of higher inflation. As a result, with rising inflation, interest rates tend to rise. The opposite happens when inflation declines.

Unemployment

There is an inverse relationship between the rate of unemployment and the rate of inflation in an economy. It has been observed that there is a stable short run trade-off between unemployment and inflation. This inverse relationship between unemployment and inflation is called the Phillip’s Curve. when an economy is witnessing higher growth rates, unless it is a case of stagflation, it typically accompanies a higher rate of inflation as well. However, the surging growth in total output also creates more job opportunities and hence, reduces the overall unemployment level in the economy. On the flip side, if inflation breaches the comfort level of the respective economy, then suitable fiscal and monetary measures follow to douse the surging inflationary pressure. In such a scenario, a reduction in the inflation level also pushes up the unemployment level in the economy.

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Why Macroeconomics is important for the Investors?

For Investors or people in finance, understanding macroeconomics and its factor is very important because each of the major macroeconomic factors such as growth, inflation, business cycles etc.., have strong impact on the financial markets. They also have strong impact on the financial sector.

For example, when the economy gets into downturn, many firms find it difficult to repay their loans and as a result, the financial health of banks gets affected. Furthermore, changes in macroeconomic policies influence key variables of financial markets such as interest rates, liquidity and capital flows.

On the other hand, what is happening in the financial market can have a strong impact on the rest of the economy. Some examples of such transmission can be observed during the financial crises. In the United States, weaknesses in the financial sector stemming from a sudden and substantial decline in the prices of real estate, led to a downturn for the entire economy. In fact, almost all the countries of the world were affected because of this problem in the United States. In many countries across the world, this crisis hit not only the financial markets but also the entire economy, causing major recession and unemployment. The governments of these countries had to undertake serious coordinated policy measures to pull their economies out from recession.
As finance and macroeconomics are intimately interlinked, it becomes imperative for a finance professional to have at least a working knowledge of macroeconomics, so that they can better predict how firms and individuals behave in different situations, what risks and opportunities arise in what macroeconomic situation, how changes in policy changes can affect different macroeconomic variables and so on.

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what is T+2 or T+3 days settlement in share trading?

Indian and European capital markets follows T+2 Rolling Settlement whereas countries like South Africa and United States follows T+3 settlement.

• T is the transaction date
• ‘+2’ or ‘+3’ denotes the number of days for settlement

Thus, trades done on Monday are settled 2 working days later viz. Wednesday and In case of T+3 days, settlement is made after 3 working days i.e. on Thursday.

All transactions executed on the stock exchanges are to be settled through the Clearing Corporation/House of the stock exchanges. However, the following exceptions are provided:

• Total connectivity failure to the exchange/STP (Specific connectivity issues of the custodians and members are not to be considered as valid exceptions).
• International Holidays that may be decided upfront by the stock exchanges in consultation with the custodians.
• Closing down of national/international centres due to calamities.

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