Pariksha SaathiLesson 3 of 10 · Indian Economy
Money, Money Supply, Inflation and Price Indices (CPI and WPI)
Drafted with AI assistance and fact-checked on 28 October 2026; not yet read line by line by a human editor. Spotted a mistake? Tell us. Editorial standards & corrections
Functions and forms of money
Money removes the main problem of barter, the need for a double coincidence of wants. Its primary functions are to act as a medium of exchange and a measure of value (unit of account); its secondary functions are to serve as a store of value and a standard of deferred payments, so that loans can be repaid later in the same unit. Money has moved from commodity money such as grain and cattle to metal coins, then to paper money and now to bank deposits and digital money. Modern paper money is fiat money: it has value because the government declares it legal tender, not because of the material it is made of.
Who issues money in India
The RBI issues currency notes under Section 22 of the RBI Act 1934, while coins and one-rupee notes are issued by the Government of India; that is why a one-rupee note carries the signature of the Finance Secretary and other notes that of the RBI Governor. Coins are minted at government mints in Mumbai, Hyderabad, Kolkata and Noida. Since 1957 the RBI has followed the Minimum Reserve System: it must hold gold and foreign exchange worth at least Rs 200 crore, of which gold must be worth at least Rs 115 crore, and the amount of notes issued is not tied to this reserve.
Measures of money supply
M0, reserve money or high-powered money, is currency in circulation plus bankers' deposits with the RBI plus other deposits with the RBI; it is the base on which bank money is built. Above it are the RBI's four measures of money supply, adopted in 1977 and running from the most liquid to the least. M1, narrow money, is currency with the public plus demand deposits with banks plus other deposits with the RBI. M2 is M1 plus savings deposits with post office savings banks. M3, broad money, is M1 plus time deposits with banks and is the measure most used in policy. M4 is M3 plus all deposits with post office savings banks other than National Savings Certificates. The ratio of broad money to reserve money is the money multiplier: a change in M0 causes a larger change in M3 because banks lend out part of every deposit.
What inflation is and why it happens
Inflation is a sustained rise in the general price level, which means a fall in the purchasing power of money. Demand-pull inflation arises when total demand runs ahead of supply, often because of fast money growth or heavy government spending: too much money chasing too few goods. Cost-push inflation arises when costs such as wages, oil or raw materials rise, or when a drought or another supply shock cuts output. By speed, inflation is called creeping (mild), walking, running or galloping, and hyperinflation when prices rise extremely fast. Inflation helps borrowers and hurts lenders and people on fixed incomes, because their money buys less.
Related terms
Stagflation is high inflation together with stagnant output and high unemployment, as many countries saw after the oil shocks of the 1970s. Deflation is a fall in the general price level; it is harmful because people postpone spending and the real burden of debt rises. Disinflation is a fall in the rate of inflation: prices still rise, only more slowly. Reflation is a deliberate policy push to raise output and prices after a slump. Headline inflation covers all items in an index, while core inflation leaves out volatile food and fuel prices to show the underlying trend.
WPI and CPI
The Wholesale Price Index (WPI) is published by the Office of the Economic Adviser in the Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce and Industry. It covers only goods, in three groups: primary articles, fuel and power, and manufactured products, the last having the largest weight; services are not included. The Consumer Price Index (CPI) measures the retail prices households pay for goods and services, and food has a large weight in it. The NSO publishes CPI (Rural), CPI (Urban) and CPI (Combined), a series begun in 2011, while the Labour Bureau, Shimla, publishes the CPI for Industrial Workers (CPI-IW) and for agricultural and rural labourers. WPI was India's main inflation measure until 2014; since then CPI (Combined) has been the headline measure and the basis of the RBI's inflation target.
The Phillips curve in plain words
In 1958 the economist A.W. Phillips, studying British data, found that years of low unemployment were years of fast-rising wages, while years of high unemployment had slow wage growth. Drawn as a downward-sloping curve, this suggests a short-run trade-off: lower unemployment can be had at the cost of higher inflation, and lower inflation at the cost of more unemployment. The stagflation of the 1970s, when both were high together, showed that the trade-off is not stable. Economists such as Milton Friedman argued that in the long run the curve is vertical, because people come to expect inflation and unemployment returns to its natural rate.
Key facts
- Functions of money: primary - medium of exchange and measure of value; secondary - store of value and standard of deferred payments.
- Currency notes are issued by the RBI (Section 22, RBI Act 1934); coins and one-rupee notes by the Government of India (signed by the Finance Secretary).
- Minimum Reserve System since 1957: at least Rs 200 crore of gold and foreign exchange, of which at least Rs 115 crore in gold.
- M0 = reserve (high-powered) money; M1 = narrow money (currency with public + demand deposits + other deposits with RBI); M3 = broad money (M1 + time deposits).
- Liquidity order: M1 is the most liquid and M4 the least; money multiplier = M3 / M0.
- Demand-pull: excess demand; cost-push: rising input costs or supply shocks; stagflation: high inflation with stagnation and unemployment.
- Deflation = falling prices; disinflation = falling rate of inflation; reflation = deliberate revival of prices and output.
- WPI: Office of the Economic Adviser, DPIIT; goods only, no services; groups - primary articles, fuel and power, manufactured products.
- CPI Rural/Urban/Combined: NSO; CPI-IW, CPI-AL and CPI-RL: Labour Bureau; CPI (Combined) has been the headline inflation measure since 2014 and is the basis of the RBI's inflation target.
- Phillips curve (A.W. Phillips, 1958): inverse short-run link between unemployment and inflation; vertical in the long run.
Quick revision
Money: medium of exchange, measure of value, store of value, deferred payments; notes by RBI (Sec 22), coins and Re 1 note by GoI; Minimum Reserve System 1957 (Rs 200 crore, gold Rs 115 crore); M0 reserve money, M1 narrow, M3 broad (measures from 1977); demand-pull vs cost-push; stagflation, deflation, disinflation; WPI by OEA (DPIIT), goods only; CPI by NSO, CPI-IW by Labour Bureau; CPI (Combined) headline since 2014; Phillips curve 1958.