The monetary system refers to a set of institutions that provides a supportive framework for the creation of money in an economy by the government.
There are 3 types of monetary system:
- Commodity money
- Commodity-based money
- Fiat money
The most common type of monetary system is Fiat money.
In this article, the various types of monetary systems are discussed along with important terms related to money which holds relevance for the IAS Exam.
Monetary System (UPSC Notes):- Download PDF Here
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Types of Monetary system
The types of the monetary system are discussed below:
Commodity Money
Commodity money is the type of money that is made of precious metals or commodities that have intrinsic value. It is not just a token or representative of monetary value like banknotes. Its worth remains intact even after it is melted. Gold and silver coins are the perfect example of commodity money.
Commodity-based money
This type of monetary system can also be addressed as representative money. This type of currencies are mostly like physical bank-notes with no financial value but can be exchanged with precious metals like gold and silver. This is closely related to the term gold standard.
Fiat Money
This type of money is also termed as legal tender as notified by the Central Government and Central Bank. This is unlike the commodity money; it might not have an intrinsic value. Paper currencies and metal coins are examples of fiat money.
In modern economies or current phase, it mainly exists as data such as bank balances and records of credit or debit card purchases.
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Important terms related to Money
Money – Anything which has general acceptance as a means of payment.
Functions of Money
Medium of Exchange
- Common measure of value
- Standard for deferred payments
- Store of wealth
Barter System – A commodity is exchanged for other commodities.
- Problems of barter System are:-
- Double coincidence of what is required
- Valuation of commodities exchanged is a problem
- There won’t be a standard to serve as future monetary obligations
Gresham’s Law – Bad money drives out good money
Legal Tender Money – This money cannot be denied in the settlement of the monetary obligation
- Limited Legal Tender Money: It is compulsory to accept up to a certain limit
Example – A sum of 10 can be paid in denominations of 50 paisa coins and the recipient has to legally accept it.
- Unlimited Legal Tender Money: This money can be used to make any amount of payment
Non-Legal Tender Money – There is no legal compulsion to accept this money. It is also called optional money or Fiduciary Money (on the basis of trust).
- E.g. – Nepalese currency at India – Nepal border may be used as but the recipient is not legally bound to accept it.
Near Money – Highly liquid financial assets like shares and bonds
For similar notes on important Economy topics, check the linked article.
Monetary System (UPSC Notes):- Download PDF Here
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