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come down. However, if the market rate of interest is already low enough so that everybody expects it to rise in future, causing capital losses, nobody will wish to hold bonds. Everyone in the economy will hold their wealth in money balance and if additional money is injected within the economy it will be used up to satiate people’s craving for money balances without increasing the demand for bonds and without further lowering the rate of interest below the floor r . Such a situation is called a liquidity trap. The min speculative money demand function is infinitely elastic here. In Fig. 3.1 the speculative demand for money is plotted on the horizontal axis and the rate of interest on the vertical axis. When r = r , max speculative demand for money is zero. The rate of interest is so high that everyone expects it to fall in future and hence is sure about a future capital gain. Thus everyone has converted the speculative money balance into bonds. When r = r min, the economy is in the liquidity trap. Everyone is sure of a future rise in interest rate and a fall in bond prices. Everyone puts whatever wealth they acquire in the form of money and the speculative demand for money is infinite. Total demand for money in an economy is, therefore, composed of transaction demand and speculative demand. The former is directly proportional to real GDP and price level, whereas the latter is inversely related to the market rate of interest. The aggregate money demand in an economy can be summarised by the following equation M = M + M d T S rmax –r or, M = kPY + (3.5) r – rmin T HES UPPLYOFM ONEY : VARIOUSM EASURES 47 In a modern economy money consists mainly of currency notes and coins M issued by the monetary authority of the country. In India currency notes n are issued by the Reserve Bank of India (RBI), which is the monetary y n authority in India. However, coins are issued by the Government of India. B Apart from currency notes and coins, the balance in savings, or current n account deposits, held by the public in commercial banks is also considered i g money since cheques drawn on these accounts are used to settle transactions. Such deposits are called demand deposits as they are payable by the bank on demand from the account-holder. Other deposits, e.g. fixed deposits, have a fixed period to maturity and are referred to as time deposits. Though a hundred-rupee note can be used to obtain commodities worth Rs 100 from a shop, the value of the paper itself is negligible – certainly less than Rs 100. Similarly, the value of the metal in a five-rupee coin is probably not worth Rs 5. Why then do people accept such notes and coins in exchange of goods which are apparently more valuable than these? The value of the currency notes and coins is derived from the guarantee provided by the issuing authority of these items. Every currency note bears on its face a promise from the Governor of RBI that if someone produces the note to RBI, or any other commercial bank, RBI will be responsible for Reprint 2026-27