Modern forms of money include currency — paper notes and coins. Unlike the things that were used as money earlier, modern currency is not made of precious metals such as gold, silver, and copper. And unlike grain and cattle, they are neither of everyday use. The modern currency is without any use of its own. Then, why is it accepted as a medium of exchange? It is accepted as a medium of exchange because the currency is authorized by the government of the country.
In India, the Reserve Bank of India issues currency notes on behalf of the central government. As per Indian law, no other individual or organization is allowed to issue currency. Moreover, the law legalizes the use of a rupee as a medium of payment that cannot be refused in settling transactions in India. No individual in India can legally refuse a payment made in rupees. Hence, the rupee is widely accepted as a medium of exchange.
Deposits with Banks
The other form in which people hold money is as deposits with banks. At a point in time, people need only some currency for their day-to-day needs. For instance, workers who receive their salaries at the end of each month have extra cash at the beginning of the month. What do people do with this extra cash? They deposit it with the banks by opening a bank account in their name.
Banks accept the deposits and also pay an interest rate on the deposits. In this way, people’s money is safe with the banks and it earns interest. People also have the provision to withdraw the money as and when they require it. Since the deposits in the bank accounts can be withdrawn on demand, these deposits are called demand deposits.
Demand deposits offer another interesting facility. It is this facility that lends it the essential characteristics of money (that of a medium of exchange). You would have heard of payments being made by cheques instead of cash. For payment through cheque, the payer who has an account with the bank makes out a cheque for a specific amount.
A cheque is a paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been made. Thus we see that demand deposits share the essential features of money. The facility of cheques against demand deposits makes it possible to directly settle payments without the use of cash.
Since demand deposits are accepted widely as a means of payment, along with currency, they constitute money in the modern economy. You must remember the role that the banks play here. But for the banks, there would be no demand deposits and no payments by cheques against these deposits. The modern forms of money — currency and deposits — are closely linked to the working of the modern banking system.