Issue of paper money

 PRINCIPLE OF NOTE ISSUE

To ensure a good note issue system, two principles of note issue have been advocated:- 

(a) CURRENCY PRINCIPLE

(b) BANKING PRINCIPLE


(A) CURRENCY PRINCIPLE:-  It is based on the assumption that a sound system of note issue should command the greatest public confidence. This requires that the note issue should be backed by 100% gold or silver reserves. Or in other words, paper currency should be fully convertible into gold or silver. Thus, according to this principle, the supply of paper currency is subjected to the availability of metallic reserves and varies directly with the variations in the metallic reserves.


MERITS:- 

1) It has maximum public confidence

2) There is no danger of over issue of notes leading to inflation

3) It makes the paper currency sstems automatic and leaves nothing to the will of monetary authority.


DEMERITS:-

1) It makes the monetary system inelastic as it does not allow the monetary authority to expand the supply according to the demand.

2) It makes the monetary system expensive and uneconomical

3) It is not practical for all countries because gold and silver are unevenly distributed among countries.


(B) BANKING PRINCIPLE:- It is based on the assumption that the common man is not much interested in getting his currency notes converted into gold or silver. Therefore 100% metallic reserves may not be necessary against note issue. It is sufficient to keep only a certain percentage of total paper currency in the form of gold or silver reseeres. This principle is derived from the practice of commercial banks to keep only a certain proportion of cash reserves against their total deposits.


MERITS:-

1) It provides elasticity to the monetary system.

2) It is the most economica principle and thus can be followed by both rich and poor countries.


DEMERITS:-

1) It is inflationary in nature because it  involves danger of note issue.

2) It does not command public confidence.


CONCLUSION

(1) Both the currency principle and the banking principle fail to satisfy all the requirements of a good note issue system. The former ensures security and public confidence, but it lacks elasticity, economy and practicability. On the contrary, the latter provides elasticity and economy to the note issue system, but it suffers from the drawback of over issue and loss of public confidence.


(2) Despite the incompleteness of both the principle, the banking principle, rather than the currency principle, has been preferred and widely accepted in the modern times mainly because of its emphasis on the qualities of elasticity, economy and practicability of the note issue system. The quality of convertibility, which is basic to currency principle, is no longer considered as necessary requirement for a good note issue system.


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