Indian Economy: Money, Banking, and Inflation

Money and Inflation are among the most frequently tested economics topics in Kerala PSC exams. Questions cover types of money, measures of money supply, inflation types, price indices, and RBI’s monetary policy tools. Expect 2-4 questions per paper.

Types of Money

Type	Details
Commodity Money	Money that has intrinsic value (gold coins, silver coins, shells)
Fiat Money	Money by government decree; no intrinsic value (paper currency, coins today)
Fiduciary Money	Based on trust (cheques, bank drafts — promise to pay)
Legal Tender	Must be accepted for payment by law; cannot be refused
Near Money	Highly liquid assets that can be quickly converted to cash (treasury bills, bonds, fixed deposits)

Legal Tender in India

Type	Details
Unlimited Legal Tender	Currency notes (all denominations) — can be used for any amount of payment
Limited Legal Tender	Coins — can be used up to a certain limit (coins up to 25 paise: up to Rs. 25; coins of Rs. 1 and above: up to Rs. 1000)
Currency notes issued by	Reserve Bank of India (except Re. 1 note — issued by Ministry of Finance)
Coins issued by	Government of India (Ministry of Finance)
Re. 1 note signed by	Finance Secretary
Other notes signed by	RBI Governor

Measures of Money Supply

Measure	Components	Liquidity
M1 (Narrow Money)	Currency with public + Demand deposits with banks + Other deposits with RBI	Most liquid
M2	M1 + Savings deposits with Post Office savings banks
M3 (Broad Money)	M1 + Time deposits with banks	Most commonly used indicator
M4	M3 + All deposits with Post Office savings banks (excluding NSCs)	Least liquid

Note: M1 is most liquid; M4 is least liquid. M3 is the most commonly used measure of money supply.

Inflation

Concept	Details
Definition	Sustained increase in general price level of goods and services over a period of time
Effect	Reduces purchasing power of money
Measured by	Price indices (CPI, WPI)
Opposite	Deflation (sustained decrease in price level)
Controlled by	RBI (monetary policy) and Government (fiscal policy)

Types of Inflation — By Cause

Type	Cause	Details
Demand-Pull Inflation	Excess demand	Too much money chasing too few goods; aggregate demand exceeds aggregate supply
Cost-Push Inflation	Rising production costs	Increase in wages, raw material prices, or taxes raises cost; passed to consumers
Structural Inflation	Structural bottlenecks	Supply-side constraints in developing economies (poor infrastructure, agriculture failures)
Imported Inflation	External factors	Rise in import prices (e.g., crude oil price increase raising domestic fuel and transport costs)

Types of Inflation — By Rate

Type	Rate	Details
Creeping Inflation	1-3% per year	Mild; considered normal and healthy for economy
Walking/Trotting Inflation	3-10% per year	Moderate; warning signal
Running Inflation	10-20% per year	Serious; requires strong measures
Galloping Inflation	20-100% per year	Very rapid; economy distorted
Hyperinflation	Above 100% (or 50%/month)	Currency becomes almost worthless; e.g., Zimbabwe (2008), Venezuela, Weimar Germany (1923)

Other Inflation-Related Terms

Term	Definition
Deflation	Sustained fall in general price level; increases purchasing power but harmful (reduced investment, unemployment)
Disinflation	Reduction in the rate of inflation (inflation is positive but declining)
Stagflation	High inflation + high unemployment + stagnant economic growth simultaneously
Reflation	Deliberate policy to stimulate economy after deflation (increasing money supply, government spending)
Skewflation	Inflation in some sectors while others remain stable (e.g., food prices rising while industrial prices stable)
Core Inflation	Inflation excluding volatile food and fuel prices
Headline Inflation	Total inflation including food and fuel

Price Indices in India

Consumer Price Index (CPI)

Fact	Details
Measures	Change in prices of a basket of goods and services purchased by consumers
Base year (current)	2012 = 100
Published by	Central Statistics Office (CSO) — now National Statistical Office (NSO)
Frequency	Monthly
Used for	RBI inflation targeting (since April 2014); monetary policy decisions
RBI target	4% CPI inflation (with tolerance band of +/- 2%, i.e., 2-6%)
Components	Food and beverages (45.86%), Housing (10.07%), Fuel and light (6.84%), Clothing (6.53%), etc.

Wholesale Price Index (WPI)

Fact	Details
Measures	Change in wholesale prices (producer/manufacturer level)
Base year (current)	2011-12 = 100
Published by	Office of Economic Adviser, Department for Promotion of Industry and Internal Trade (DPIIT)
Frequency	Monthly (weekly discontinued since 2012)
Does not include	Services (only manufactured goods, primary articles, fuel and power)
Major components	Manufactured products (64.23%), Primary articles (22.62%), Fuel and power (13.15%)

CPI vs WPI Comparison

Feature	CPI	WPI
Measures	Retail prices	Wholesale prices
Includes services	Yes	No
Used by RBI for targeting	Yes (since 2014)	No (was used earlier)
Published by	NSO (MoSPI)	DPIIT (Commerce Ministry)
More relevant for	Consumers/households	Manufacturers/traders
Base year	2012	2011-12

Phillips Curve

Concept	Details
Proposed by	A.W. Phillips (1958)
Shows	Inverse relationship between unemployment rate and rate of inflation
Meaning	Low unemployment = high inflation; high unemployment = low inflation
Implication	Government faces trade-off between inflation and unemployment
Stagflation challenge	Stagflation (1970s) contradicted Phillips Curve — both high inflation AND high unemployment simultaneously
Long-run view (Friedman)	In long run, Phillips Curve is vertical — no trade-off exists; economy settles at natural rate of unemployment

RBI Monetary Policy Tools

Quantitative Tools

Tool	How It Works
Repo Rate	Rate at which RBI lends short-term money to banks; increase = tightens money supply = controls inflation
Reverse Repo Rate	Rate at which RBI borrows from banks; increase = banks park more money with RBI = reduces money in system
CRR (Cash Reserve Ratio)	Percentage of deposits banks must keep with RBI as cash; increase = less money to lend
SLR (Statutory Liquidity Ratio)	Percentage of deposits banks must maintain in gold/government securities/cash; increase = less money to lend
Bank Rate	Rate at which RBI lends long-term to banks (without collateral); higher than repo rate
Open Market Operations (OMO)	RBI buys/sells government securities; buying = injects money; selling = absorbs money

Qualitative Tools

Tool	How It Works
Margin Requirements	Minimum gap between loan amount and security value; higher margin = less borrowing
Moral Suasion	RBI persuades/advises banks informally
Selective Credit Controls	Directives on lending to specific sectors
Credit Rationing	Fixing ceiling on loans to specific sectors

Current Key Rates (as of early 2026, approximate)

Rate	Value
Repo Rate	6.00%
SDF (Standing Deposit Facility)	5.75%
MSF (Marginal Standing Facility)	6.25%
Bank Rate	6.25%
CRR	4.00%
SLR	18.00%

Monetary Policy Committee (MPC)

Fact	Details
Established	2016 (under RBI Act amendment)
Members	6 (3 from RBI + 3 external appointed by Government)
Chairman	RBI Governor
Function	Sets repo rate; inflation targeting
Target	CPI inflation at 4% (+/- 2%)
Meetings	At least 4 times a year
Decision by	Majority vote; Governor has casting vote in case of tie

Inflation and Its Impact

Group	Effect of Inflation
Debtors	Benefit (repay in cheaper money)
Creditors	Lose (receive money with less purchasing power)
Fixed income groups	Lose (salary/pension buys less)
Businessmen/entrepreneurs	Generally benefit (sell at higher prices)
Government (as debtor)	Benefits (real value of debt decreases)
Farmers	Mixed — benefit if commodity prices rise but hurt by input cost inflation

Quick Recall — PSC Favourites

Question	Answer
Currency notes issued by?	RBI (except Re. 1 — Ministry of Finance)
Re. 1 note signed by?	Finance Secretary
Most liquid measure of money supply?	M1
Most commonly used measure?	M3 (Broad Money)
RBI inflation target?	4% CPI (tolerance band 2-6%)
CPI base year?	2012
WPI base year?	2011-12
CPI published by?	NSO (National Statistical Office)
WPI published by?	DPIIT
Phillips Curve shows?	Inverse relation between inflation and unemployment
Stagflation means?	High inflation + high unemployment + stagnant growth
Deflation means?	Sustained fall in price level
Repo rate is?	Rate at which RBI lends to banks (short-term, with collateral)
Increase in CRR leads to?	Less money supply (contractionary)
MPC has how many members?	6
MPC Chairman?	RBI Governor
Demand-pull inflation caused by?	Excess demand over supply
Hyperinflation example?	Zimbabwe (2008), Weimar Germany (1923)