What Is Barter Or A Barter System?

Definition And Examples

Barter is the exchange of products and services for other products and
services. In a barter system, people do not use money for transactions. The verb ‘to
barter’ means to exchange goods and services for other products and services.

A. Meaning of Barter:
‘Direct exchange of goods against goods without use of money is called barter
exchange.’

Alternatively, economic exchanges without the medium of money are referred to

as barter exchanges. An economy based on barter exchange (i.e., exchange of
goods for goods) is called C.C. Economy, i.e., commodity for commodity
exchange economy. In such an economy, a person gives his surplus good and gets
in return the good he needs.

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For example, when a weaver gives cloth to the farmer in return for getting wheat
from the farmer, this is called barter exchange. Similarly the farmer can get other
goods of his requirement like shoes, cow, plough, spade, etc. by giving his surplus
wheat (or rice or maize). Thus, the system of barter exchange fulfills to some
extent the requirements of both the parties involved in exchange.

However, as the transactions increased, inconveniences and difficulties of barter

exchange also increased involving rising trading costs. Trading costs are costs of
engaging in trade. Its two components are search cost and disutility of waiting.

Remember, search cost is the high cost of searching suitable persons to exchange
goods and disutility of waiting refers to time period spent on searching the required
person. This ultimately led to evolution of money as medium of exchange.
Following are some of the drawbacks or inconveniences of barter.

B. Inconveniences (Problems) of Barter Exchange:

1. Lack of double coincidence of wants:

Double coincidence of wants means what one person wants to sell and buy must
coincide with what some other person wants to buy and sell. ‘Simultaneous
fulfillment of mutual wants by buyers and sellers’ is known as double coincidence
of wants.

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There is lack of double coincidence in the wants of buyers and sellers in barter
exchange. The producer of jute may want shoes in exchange for his jute. But he
may find it difficult to get a shoe-maker who is also willing to exchange his shoes
for Jute.

Thus, a seller has to find out a person who wants to buy sellers good and at the
same time who must have what the seller wants. This is called double coincidence
of wants which is the main drawback of the barter exchange.

2. Lack of common measure of value:

In barter, there is no common measure (unit) of value. Even if buyer and seller of
each other commodity happen to meet, the problem arises in what proportion the
two goods are to be exchanged. Each article must have as many different values as
there are other articles for which it is to be exchanged.

3. Lack of standard of deferred payment:

There is problem of borrowing and lending. It is difficult to engage in contracts
which involve future payments due to lack of any satisfactory unit. As a result,
future payments are to be stated in term of specific goods or services. But there
could be disagreement about the quality of the good, specific type of the good and
change in the value of the good.

4. Difficulty in storing wealth (or generalised purchasing power):

It is difficult for the people to store wealth or generalised purchasing power for
future use in the form of goods like cattle, wheat, potatoes, etc. Holding of stocks
of such goods involves costly storage and deterioration.
5. Indivisibility of goods:
How to exchange goods of unequal value? If a household wants to sell his cow and
get in exchange cloth equal to the value of half of his cow, he cannot do so without
killing his cow. Thus, lack of divisibility of goods makes barter exchange
impossible.

In order to overcome the above disadvantages of the barter system, money was
invented by the society.

Credit creation process:

The process of 'Credit Creation' begins with banks lending money out of
primary deposits. Primary deposits are those deposits which are deposited in
banks. In fact banks cannot lend the entire primary deposits as they are
required to maintain a certain proportion of primary deposits in the form of
reserves with the RBI under RBI & Banking Regulation Act. After maintaining
the required reserves, the bank can lend the remaining portion of primary
deposits. Here bank's lend the money and the process of credit creation
starts.

Suppose there are a number of Commercial Banks in the Banking System –

Bank 1, Bank 2, Bank 3, & So on.

To begin with let us suppose that an individual "A" makes a deposit of Rs.
100 in bank 1. Bank "1" is required to maintain a Cash Reserve Requirement
of 5% (Prevailing Rate) which is decided by the RBI's Monetary Policy from
the deposits made by 'A'. Bank "1" is required to maintain a cash reserve of
Rs. 5 (5% of 100). The bank has now lendable funds of Rs. 95(100 – 5). Let
the Bank "1" lend Rs. 95 to a borrower; say B. the method of lending is the
same that is bank 1 opens an account in the name of the borrower cheque
for the loan amount. At the end of the process of deposits & lending, the
balance sheet of bank reads as given below:-

Balance Sheet of Bank "1"

Liabilities Amount Assets Amount

A's deposits 100 Cash Reserve 5
    Loan to "B" 95
Total 100 Total 100

Now suppose that money that borrowed from bank "1" is paid to individual
"C" in settlement of his past debts. The individual "C" deposits the money in
his bank say, bank 2. Now bank 2 carries out its banking transaction. It
keeps a cash reserve to the extend of 5%, that is Rs. 4.75 (5% of 95) and
lend Rs. 90.5 to a borrower D. at the end of the process the balance sheet of
Bank 2 will be look like:-

Balance Sheet of Bank "2"

Liabilities Amount Assets Amount

B's deposits 95 Cash Reserve 4.75
    Loan to "C" 90.5
Total 95 Total 95

The amount advanced to D will return ultimately to the banking system, as

described in case of B and the process of deposits and credit creation will
continue until the reserve with the banks is reduced to zero. The final picture
that would emerge at the end of the process of deposit & credit creation by
the banking system is presented in the consolidated balance sheet of all
banks are as under:-

The combined Balance sheet of Banks

Bank Liabilities  Assets Reserve Total

Deposits Credits Assets
Bank 1 100 95 5 100
Bank 2 95 90.5 4.75 95
Bank 3 90.5 85.98 4.52 90.5
- - - - -
- - - - -
Bank n 00 00 00 00
Total 2,000 1,900 100 2,000

It can be seen from the combined balance sheet that a primary deposits of
Rs. 100 in a bank 1 leads to the creation of the total deposit of Rs. 2,000.
The combined balance sheet also shows that the banks have created a total
credit of Rs. 2,000. And maintained a total cash reserve of Rs.100.Which
equals the primary deposits. The total deposit created by the commercial
banks constitutes the money supply by the banks. 

What Is the Reserve Ratio?

The reserve ratio is the portion of reservable liabilities that commercial banks
must hold onto, rather than lend out or invest. This is a requirement determined
by the country's central bank, which in the United States is the Federal Reserve.
It is also known as the cash reserve ratio.

As a simplistic example, assume the Federal Reserve determined the reserve

ratio to be 11%. This means if a bank has deposits of $1 billion, it is required to
have $110 million on reserve ($1 billion x .11 = $110 million).

What Does the Reserve Ratio Tell You?

The Federal Reserve uses the reserve ratio as one of its key monetary policy
tools. The Fed may choose to lower the reserve ratio to increase the money
supply in the economy. A lower reserve ratio requirement gives banks more
money to lend, at lower interest rates, which makes borrowing more attractive to
customers.

Conversely, the Fed increases the reserve ratio requirement to reduce the
amount of funds banks have to lend. The Fed uses this mechanism to reduce the
supply of money in the economy and control inflation by slowing the economy
down.

The Fed also sets reserve ratios to ensure that banks have money on hand to
prevent them from running out of cash in the event of panicked depositors
wanting to make mass withdrawals. If a bank doesn't have the funds to meet its
reserve, it can borrow funds from the Fed to satisfy the requirement.

Banks must hold reserves either as cash in their vaults or as deposits with a
Federal Reserve Bank. On Oct. 1, 2008, the Federal Reserve began paying
interest to banks on these reserves. This rate is referred to as the interest rate on
required reserves (IORR). There is also an interest rate on excess
reserves (IOER), which is paid on any funds a bank deposits with the Federal
Reserve in excess of their reserve requirement.

What is CRR, SLR & Repo Rate?

Reserve Bank of India (RBI), the central bank, one of its primary functions is to
control the supply as well as the cost of credit. Which means how much money is
available for the industry or the economy and what is the price that the economy has
to pay to borrow that money which is nothing but liquidity and interest rates.
So, RBI has a role to play to control these two things because eventually these two
have an impact on the inflation and growth in the economy. For this, RBI has got
some tools available in their hands and these tools are maintaining certain basic ratios
or maintaining certain rates.

Repo rate is a rate at which banks borrow from RBI for short periods up to 7 or 14
days but predominantly overnight. RBI manages this repo rate which is the cost of
credit for the bank. This becomes a floor below which the short-term interest rates
don’t go. Higher the repo rate means the cost of short-term money is very high. Lower
the repo rate means the cost of short-term rate is low which means at higher repo rates
the economy growth may slowdown whereas at lower repo rate economy growth may
get enhanced.

CRR and SLR are the two ratios. CRR is a cash reserve ratio and SLR is statutory
liquidity ratio. Under CRR a certain percentage of the total bank deposits has to be
kept in the current account with RBI which means banks do not have access to that
much amount for any economic activity or commercial activity. Banks can’t lend the
money to corporates or individual borrowers, banks can’t use that money for
investment purposes. So, that CRR remains in current account and banks don’t earn
anything on that.

SLR, statutory liquidity ratio is the amount of money that is invested in certain
specified securities predominantly central government and state government
securities. Once again this percentage is of the percentage of the total bank deposits
available as far as the particular bank is concerned. The SLR, the money goes into
investment predominantly in the central government securities as I mentioned earlier
which means the banks earn some amount of interest on that investment as against
CRR where it earns zero.

Let us look at this combination of CRR and SLR. That is the amount of money which
remains blocked for statutory reasons and is not available for investment in various
other high earning avenues like loans are securities markets or other bonds. That
means it puts a certain amount of pressure on the banks balance sheets. However, at
the same time that money remains safe and with that mechanism RBI also offers
safety to the depositors who have invested money in the banks. 

The Monetary Policy Framework of Bangladesh Bank

Introduction: The monetary policy framework of Bangladesh Bank identifies a logical and sequential set
of actions for designing and conducting the monetary policy. The framework is based on credible
information on the stability of the money demand function, the money supply process, and the
monetary transmission mechanism. Monetary policy in Bangladesh is framed using projected real GDP
growth rate. The targeted rate of inflation adopts Reserve Money (RM) and Broad money (M2) as
operating and intermediate targets respectively. Within the framework, the monetary policy aims at
supporting highest sustainable output growth along with reasonable price stability and smooth
adjustment to internal and external shocks faced by the economy. The process uses repo, reverse repo,
and Bangladesh Bank bill rates as policy instruments for influencing financial and real sector prices
toward the targeted path of inflation. The underlying assumption is that growth of monetary aggregates
(such as RM and M2) has a predictable relationship with the domestic price level. Therefore, by
controlling the growth of monetary aggregates, Bangladesh Bank aims at achieving price stability. In
practice, Bangladesh Bank sets a growth rate of RM that is deemed to be consistent with targeted
inflation and output growth, with the idea that the RM growth will in turn lead, through money
multiplier, to a given growth rate of M2 in the economy. Monetary policy consists of a set of rules that
aim at regulating the supply of money in accordance with predetermined goals. Monetary policy is
important because it can influence economic growth, inflation, and the balance of payments (BOP). The
central bank conducts monetary policy by using instruments that influence the supply of money and
interest rates in the economy. The fundamental objective of pursuing monetary policy by the central
bank is to ensure that the expansion in the money supply is consistent with the objectives of the
government policies for economic growth, inflation, and the BOP. In conducting monetary policy, the
central bank tries to ensure that the supply of money is in line with the amount of money demanded by
18 the economic agents: households and firms. The main policy goals of monetary policy of Bangladesh
Bank are: • To achieve sustainable economic growth • To maintain price stability • To attain sustainable
BoP.

Flow chart-1: Monetary Policy Framework of Bangladesh Bank

Transmission Mechanism of Monetary Policy: Various operating targets, intermediate targets, and policy
objectives that central banks commonly use and pursue are given in table-3.1.
Effects of Indirect Instruments on the Money Supply:
Historically, the direct instruments to control the money supply have been popular, particularly in
developing countries. However, the more recent trend has been to substitute indirect instruments for
direct instruments. Three examples below show as to how Bangladesh Bank can use indirect
instruments to increase or decrease the money supply.

Required Reserve Ratio:

The required reserve ratio is the amount of reserves as a percentage of their deposits that banks are
required to hold. These reserves may be held in the form of cash in the vault or as deposits with the
Bangladesh Bank. Bangladesh Bank can decide whether or not it will pay interest on these deposits.
Changes in reserve requirement affect the money supply by causing the money multiplier to change.

For example: if Bangladesh Bank wants to increase the money supply, it decreases the required reserve
ratio. As soon as it does, deposit money banks (DMBs) have additional free reserve that they can lend.
Because reserves generally earn no interest, banks will increase their lending until all unutilized reserves
are invested in interest- earning assets. The increase in bank credit increases the money supply. If BB
wants to decrease the money supply, it increases the required reserve ratio. To increase their reserves,
DMBs must decrease their lending. This leads to decline in money supply. The present reserve
requirement ratio of Bangladesh Bank is 23% of which 5% is cash reserve requirement (CRR) and 18%
statutory liquidity reserve (SLR).

Discount Rate (Bank Rate):

The discount rate is the rate of interest that Bangladesh Bank charges DMBs for credit. Changes in the
discount rate affect the money supply by affecting the volume of discount loans and the monetary base.
A rise in discount loans adds to the monetary base and expands money supply. Conversely, a fall in
discount loans reduces the monetary base and shrinks money supply. For example, Bangladesh Bank
increases the discount rate to money suppy. DMBs pay more for Bangladesh Bank credit. Typically,
DMBs will increase the lending rate charged from the private sector, and the demand for credit by the
private sector will decrease. The current discount rate is 5%.

Open Market Operations:

For controlling the monetary base, Bangladesh Bank carries out open market operations (OMO). When
the central bank engages in open market operations, it buys or sells government securities, bonds in
transactions with DMBs. For example, Bangladesh Bank can buy or sell government securities in open
market operations to change the quantity of money available. Open market purchases expand the
monetary base, thereby raising the money supply. In a repurchase agreement (often called a repo),
Bangladesh Bank purchases securities with an agreement that the seller will repurchase them in a short
period of time. On the other hand, open market sales shrink the monetary base, lowering the money
supply. In a reverse repo transaction, Bangladesh Bank sells securities and the buyer agrees to sell them
back to the BB in near future. Of the three indirect instruments of monetary policy, open market
operations seem to be the most effective tool. This is because open market operations are the primary
determinants of change in the monetary base. Moreover, they occur at the initiative of the central bank,
are easily reversed, and can be implemented quickly.

Narrow Money (M1):

M1 consists of: • Currency in circulation (C) which includes the notes and coins that we use plus, •
Demand Deposits (DD) in the banking system. Deposits are also money, because they can be converted
into currency and are used to settle debts e.g, current account, savings account, traveler's check etc. So,
we can write the equation as, M1= C+DD …………………..(1)

Quasi Money (QM)

includes time and savings deposit (TD) in the banking system and any foreign currency deposit (FC) of
residents; QM = TD+FC ……………………(2)

Broad Money (M2)

includes all liabilities of the banking system. It is defined as: Broad Money = Narrow money + Quasi
money So, M2 = M1+QM…………………….(3)

M2 includes everything in M1

Adds:

–Savings deposits (SD) e.g, Post Office savings deposit.

–Small denomination time deposits (TD) e.g, different fixed deposits,

–Foreign currency deposits ( FC)

So, this equation can also be written as, M2=M1+SD+TD+FC

The basic balance equation of the monetary survey states that total liabilities are equal to total assets. It
implies that broad money (M2) is identical to net foreign assets (NFA) plus net domestic assets (NDA):

M2 = NFA+ NDA…………………(4)