1. REPRESENTATIVE PAPER CURRENCY :- This system is also called as full reserve system. Under this system, the currency note issued by the central bank are fully backed by the reserves of gold/silver. This is also called 100% reserve system of note issue. In other words, in this system notes are used as representative of gold. It means government instead of minting gold coins prints the currency note. Government gives the promise to return the equal value who demands it by returning the note to the government. Thus these currency notes were used as representatives to gold. This system is costly as it requires 100% gold reserves but at the same time it is simple to manage as it enjoys full of the people. This system is inelastic as government cannot print more notes if gold is not available.
Merits :-
(1) Public
Confidence :- This
system has gained public confidence as it can convert currency notes into Gold
100%.
(2) No
Danger Of Inflation :- There is no chance of over issue, because paper notes is to be backed by
100% Gold reserve.
(3) Convertibility
:- This method
ensures 100% convertibility of currency notes.
(4) Simple
to Manage :- The method
is very simple to mange because every note is backed by gold reserve.
Demerits :-
(1) Costly
:- This method is
very costly because 100% gold backing is required.
(2) Inelastic
:- It is inelastic
because supply of currency cannot increase or decrease rapidly.
(3) Inconvenient
:- The system is
very inconvenient at the time of emergency.
(4) Wastage
Of Gold Reserve :-
There is wastage of gold because large amount of gold lies in the reserve and
can not be used.
2. FIXED
FIDUCIARY SYSTEM :-
Under this system the central bank of the country is permitted to issue a fixed
amount of notes without any metallic reserve (gold reserve). This limit is
called fiduciary issue and it is backed by government securities. But all notes
issued above this amount must be covered by 100% metallic reserves. This system
is safe and enjoys public trust or faith as there is a promise of
convertibility given by the government. However, it is inelastic because if
country need more money it will have to purchase the gold first which may be
difficult. This system cannot work efficiently in countries like India where
demands of currency vary from season to season. For this reason in 1927, it was
replaced by a comparatively better system known as proportional reserve system.
Merits :-
a.Convertibility :- It ensures the convertibility of
currency notes. It is because of, It is issued against Government securities
and gold reserve.
b.Public Confidence :- This system of note issue attains
public confidence since the government guarantees the convertibility of notes.
c. No Danger of Inflation :- There is less chance of over issue,
because any excess issue of paper notes is to be backed by gold reserves.
d. Easy to Manage :- According to this system the central
bank is permitted to issue fixed amount of paper currency against Govt.
securities. If currency notes are exceed this limit, the stated limit should be
covered by 100% metallic reserve. Thus, this system is very easy to manage.
e. Suitable for Developed Countries
:- This system can
work in countries where the use of cheques is sufficiently developed and where
the demand of currency from time to time does not vary much.
f. No Over issue :- There is no risk of over issue of
currency because of issue is made on the basis of gold reserve.
g. Safe Method:- According to this method, payment is
assured. Thus, it is safe method.
i. Stability :- This system facilitates stability in
price level.
Demerits :-
a. Less Elastic :- This system is less elastic since
the issue of currency beyond a certain limit requires 100% gold backing which
may not be available.
b. Costly :- This method is costly since 100%
gold backing is required beyond a certain limit and thus it may prove to be
expensive.
c. Inconvenient :- The system may be inconvenient and it may fail in the times of crisis where
large funds are required immediately.
d. Wastage Of Gold Reserves :- Under this system large amount of
gold has to be kept as reserves which is kept idle with the government.
e. Unsuitable For Developing
Countries :- This
method is unsuitable for developing countries like India where the demand for
currency varies from time to time.
f. Harmful For Business :- There should enough proportion of
currency notes to perform business activities properly. But fixed fiduciary
system reduces the same. Therefore, this system is harmful to perform business
activity.
g. Leads to Deflation :- There is no scope to issue new
currency. Therefore, it leads to deflation.
h. Outdated Method :- In modern era fixed fiduciary system
is criticized on the ground that it is old and outdated method.
i. Useless Method :- This method is criticized on the
ground that it is useless method. It is because of considerable part of gold
remain idle.
3. PROPORTIONAL
RESERVE SYSTEM :-
Under this system, the notes issued by the central bank are not fully backed by
gold/silver reserves, but are backed by certain proportional (say 40%)
gold/silver and the rest by approved securities. In India this system was
adopted in 1927 and continued till 1957.
Merits :-
a. Elasticity :- This system is elastic since gold
backing is required only upto certain proportion of the total issue.
b. Economic :- This system is economical because
100% backing is not required.
c. Public Confidence :- This system has public confidence as
it can be converted upto certain proportion.
d. Avoid Inflation :- According to this method only
limited number of currency notes can be issued. Therefore, this method can be
proved useful to avoid inflation.
e. Convertibility :- In Proportional reserve system the
conversion of currency notes into gold become possible up to some extent. It is
because of facility of conversion up to that extent.
f. Convenient :- Proportional reserve system is the
most convenient method to issue currency notes. It is because of the
proportion of currency notes and gold reserve can be changed as per need and
requirement.
g. Easy to Manage :- Proportional reserve system is very
easy to manage. It is because of the currency notes are issued in specific
proportion of gold reserve.
h. Less Risk Of Over Issue :- There is a need of surplus gold for
every new issue. Therefore, there is less risk of over issue.
i. Rapid Development :- In proportional reserve system it
becomes possible to increase the number of currency notes by changing gold
reserve. Thus, rapid development becomes possible.
Demerits :-
a. Conversion Not Possible :- This system is based on
proportionate gold reserve. But in real practice conversion of currency notes
into gold reserve is impossible.
b. Difficulties In Reduction :- It becomes very difficult to reduce
the number of currency notes. It is because of to reduce currency notes the
gold reserve should be reduced proportionately. But it becomes very difficult
to reduce that proportion due to some technical problem.
c. Dangers Of Deflation :- If gold reserve is used some where
for any purpose it reduces suddenly, it reduce the number of currency notes.
thus, it creates deflation.
d. Less Credit Creation :- In proportional reserve system the
supply of currency notes can not be increased as per need and requirement.
Therefore, it reduces credit creation.
e. Hampers The Progress :- In Proportional reserve system the
currency notes can not be increased after a specific limit. Therefore, the need
of extra currency notes can be not be fulfilled. Thus, it hampers the progress.
f. Inconvenient :- According to this method, the
specific reserve is maintained to issue currency notes. Therefore, this method
is the most inconvenient for poor nation like India.
g. Uneconomic :- According to this system, gold
reserve is needed compulsorily. Therefore, there is a need to increase gold
reserve before every new issue. Thus, this method can be proved most
uneconomic.
h. Useless During Emergency :- Additional currency notes are needed
during emergency. But in absence of gold, printing of currency notes becomes
impossible. Thus, proportional reserve system is useless during emergency.
i. Unsuitability :- In Proportional reserve system a
compulsory percentage of gold is needed. But it is unsuitable for poor nations
because of shortage of gold.
j. Wastage of Gold :- In this method a very large. Portion
of gold reserve remains useless thus, there is wastage of gold.
4. MINIMUM
RESERVE SYSTEM :- According
to minimum reserve system only specific quantity of gold reserve is maintained
to issue any number of currency notes. As nominal reserve is maintained;
Therefore it also called minimum fiduciary system. This system of currency
notes has developed to replace the various drawbacks of previous methods i.e. fixed
fiduciary system and proportional reserve system. In fixed fiduciary system
100% gold reserve was maintained as a reserve after issue of specific limit.
The issuing authority was allowed to issue the currency notes up to the value
of gold reserve only. On the other hand, in case of proportional reserve system
the currency notes can be issued in specific proportion of gold reserve. But
the basic drawback of fixed fiduciary system or proportional reserve system is
that it needs a lot of gold reserve. But it is not possible for every nation.
To avoid this drawback the method of minimum reserve system is developed.
According to this system, the Reserve Bank of India has to maintained and rest
of the amount in the form of foreign currency. This method has its own
advantages as well as limitations. Some of them are stated below.
Merits :-
a. Economical :- This system is economical because
the entire note issue need not be backed by metallic reserve. Moreover only a
minimum reserve is to be maintained.
b. Elasticity :- This method has great elasticity
because after maintaining a minimum reserve the authority can issue any amount
of currency it feels necessary. i.e. there is no upper fixed for the issue.
c. Avoids Deflation :- Under this method during crisis supply
of money can be increased. Thus it helps to avoid deflation.
d. To face Emergencies :- This method is useful, because at
times of emergencies the supply of money can be increased.
e. Ensures Full Employment And
Economics Growth :-
Sice this method provides sufficient elasticity in note issue and money
circulation, sufficient funds can be generated for requirement.
f. Convenient :-Minimum reserve system is the most
convenient method to issue currency notes. It is because of the currency notes
can be issued in any number as per need and requirement.
g. Developing Economy :- Minimum Reserve System helps for
developing econemy like India.
h. Development :- This method helps to issue any
number of currency notes. Thus, it can be provided funds for development
purposes.
i. Proper Use Of Gold :- According to minimum reserve system only limited gold
reserve is maintained. Therefore, precious metals like gold, silver etc. can be
diverted towards other important purpose.
j. Popularity :- Limited gold reserve to issue
currency notes as per minimum reserve system. Therefore, it becomes very
popular in very short period. In modern era, this system is adopted by near
about all the nations of the world.
k. Simplicity :- This system is very simple to
operate. Once minimum reserve is created the issuing authority can issue any
number of currency notes against it.
Demerits :-
a. Lacks Public Confidence :- This system does not provide
convertibility of currency notes into gold and therefore it lacks public
confidence.
b. Dangers Of Inflation :- Under this system no additional
reserves are required for increasing the supply of currency. Thus there is a
tendency towards over issue of currency and this may lead to inflation.
c. Unable To Work By Itself :- This systems requires government
intervention and is not as simple as other methods of note issue.
d. Convertibility Not possible :- It is not possible to convert notes
under this system, as their expansion is not accompanied by increase in bullion
and foreign securities.
e. Exchange Instability :- Since under the methods link is not
there between any metal, there of currency notes into gold, it lacks public
confidence.
f. Misused by Govt :- In minimum reserve system there are
higher chances of over issue of currency notes. Therefore, the Govt. may issue
unnecessary notes. Thus, this system facilities misuse.
g. Rapid Increased In Prices :- There is no link between gold
reserve and currency notes. It facilities over issue. Thus, it leads to
inflation i.e. rapid increase in price level.
h. Unsafe :- Minimum reserve system is the most
unsafe method to issue currency notes. It is because of absence of proper gold
reserve.
i. Wastage Of Gold :- In minimum reserve system some
portion of gold remain useless in the form of gold reserve. Thus, it
facilitates wastage up to that extent.
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