Method of Note Issue

 Different countries have adopted different methods of note issue. Important methods among them are:- 

(1) SIMPLE DEPOSIT SYSTEM

Under this system, the paper currency notes are fully backed by the reserves of gold or silver or both. It is based on the currency principle of note issue. It involves no danger of over issue of currency and commands maximum degree of public confidence. But this system has never been practised because it is very costly and has no elasticity of Money supply.

(2)  FIXED FIDUCIARY SYSTEM

Under this system the central bank is authorised to issue only a fixed amount of currency notes against government securities. All notes issued in excess of this limit should be fully backed by gold and silver reserves. Fiduciary issue means the issue of currency notes without the backing of gold and silver. This system was first introduced in England and India followed it between 1862 to 1920.

MERITS:- 

(1) It ensures convertibility of currency notes.

(2) It inspires public confidence since government guarantees the convertibility of notes.

(3) There is no danger of over issue of paper notes.

DEMERITS:- 

(1) It makes the monetary system less elastic. 

(2) It is a costly system. Poor countries can't afford it.

(3) It is inconvenient method because whenever gold reserves fall, the central bank has to reduce the supply of currency which disturbs the functioning of the economy.

(3) PROPORTIONAL RESERVES SYSTEM

Under this system, certain proportion of currency notes (40%) are backed by gold and silver reserves and the remaining part of the note issue by approved securities. According to the RBI Act 1933, not less than 40% of the total assets of the Issue Department should consist of gold bullion, gold coins and foreign securities, with the additional provision that gold coins and gold bullion were not at any time to be less than Rs. 40 crores. The proportional reserve system was later replaced by the minimum reserve system by the RBI (Amendment) Act, 1956.

MERITS

(1) It guarantees convertibility of paper currency.

(2) It ensures elasticity in the monetary system.

(3) It is economical and can be easily adopted by the poor countries.

DEMERITS

(1) Under this system, it is easy to expand currency but very difficult to reduce it. The reduction of currency has deflationary effects in the economy.

(2) There is wastage of gold because large amount of gold lies in the reserve and cannot be put to productive use.

(3) The convertibility of paper notes is not real. In practice, high denomination notes are converted into low denominations notes and not into coins.

(4) MINIMUM FIDUCIARY SYSTEM

Under this system, the minimum reserves of gold against note issue that the authority is required to maintain are fixed by law. Against these minimum reserves, the monetary authority can issue as much paper currency as is considered necessary for the economy. There is no upper limit fixed for the issue of currency.

This system, if ably managed, can prove very useful for developing countries. It can make available enormous resources for financing developmental schemes. This system has been in force in India since 1957. The RBI is required to keep minimum reserves of RS.200 crores of which not less than RS. 150 crores must be kept in the form of gold.

MERITS

1) It is economical because only a minimum reserve is to be maintained.

2) It renders elasticity to the monetary system.

DEMERITS

1) It has a danger of over-issue of notes and hence danger of inflation.

2) It lacks public confidence.

(5) MAXIMUM RESERVE SYSTEM

Under this system, the government fixes the maximum limit upto which the monetary authority can issue notes without the backing of metallic reserves. The monetary authority cannot issue notes beyond this limit. The maximum limit is not rigid and maybe revised from time to time according to the changing needs of the economy.

MERITS

(1) It gives elasticity to the monetary system since the power lies in the hands of Central Bank.

DEMERITS

(1) It has a danger of note issue.

(2) It lacks public confidence.

CONCLUSION

(1) The analysis of relative merits and demerits of various methods of note issue makes it difficult to identify any one method as an ideal method.

(2) A good method of note issue must possess the qualities of economy, elasticity and public confidence without being inflationary in effect.

(3) Convertibility of currency notes into some precious metal is no longer considered an important requirement because in modern times currency notes are accepted on their own merit.

(4) Keeping in view, these considerations, minimum fiduciary system can prove to be a better method, if managed ably and sincerely.