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The following points highlight the top five methods used for issuing notes. The methods are: 1. Simple Deposit System 2. Fixed Fiduciary System 3. Maximum Fiduciary System 4. Proportional Reserve System 5. Minimum Reserve System.
Method # 1. Simple Deposit System:
Under this system, the monetary authority is required to keep 100% of the bullion (gold or silver) for every note issued. That is why it is also known as the Full Reserve System. This system has certain merits. It is safe and enjoys public confidence because there is full backing of the bullion for every note issued.
The monetary authority cannot take any arbitrary decision in issuing notes. So there is no possibility of over issue of notes. There is also the saving of precious metals through debasement because metal coins are not circulated.
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However, this system lacks in elasticity firstly, because the money supply cannot be increased without the full backing of bullion reserves. This may be harmful during war or emergency or for development. It may also adversely affect trade and currency.
Second, this system is especially unsuited for poor countries lacking insufficient quantities of gold or silver. Third, it is uneconomical for it does not make a profitable use of bullion reserves lying idle with the monetary authority. Thus this system is highly impracticable in modern times. Perhaps this is the reason for its being not put into practice in any country of the world.
Method # 2. Fixed Fiduciary System:
Under this system, a fixed amount of notes is issued by the central bank against reserves of government securities. Such amount is issued on the faith or fiduciary of the central bank and is called the fiduciary limit. The central bank is required to keep 100% gold reserves beyond the fiduciary limit. The fiduciary limit is raised from time to time with the expansion of trade and industry. This system was introduced in England in 1844, in India in 1860, followed by Japan and Norway.
This system ensures security, inspires public confidence, and is without any danger of mismanaging the currency through over issue of notes by the central bank. But it has also certain disadvantages.
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First, it is a rigid and inelastic system because in times of a financial emergency, notes cannot be issued without keeping cent per cent gold in reserves.
Second, the system is inconvenient because in the event of a fall in gold reserves, the central bank has to withdraw notes from circulation with the result that the quantity of money is reduced in the country with its adverse effects on prices, trade and industry.
Third, this system is uneconomical because gold reserves are blocked up with the central bank. It was, therefore, abandoned by all countries after World War I when they faced these problems.
Method # 3. Maximum Fiduciary System:
Under this system, there is a maximum limit up to which the central bank is authorised to issue notes without any gold reserves. But there has to be full backing of gold reserves beyond this limit. The central bank is, however, authorised to raise or lower the maximum fiduciary limit and to fix the quantity of gold reserves.
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Thus this system is not rigid but is elastic. It is also economical because the gold
reserves can be kept to the minimum to meet the requirements of trade and industry.
In case the central bank fixes the fiduciary limit very high; there may be excess of notes in circulation thereby leading to inflation. This system was in operation in France, Japan, Russia, Norway, Finland and England. This system has one major defect that there is the possibility of inflation through over issue when the maximum limit may be raised by the government.
Method # 4. Proportional Reserve System:
In this system, a certain percentage of the total notes issued by the central bank has to be in gold reserves and the remaining in the form of government securities. This percentage varied between 25 to 40 per cent in countries like Switzerland, Holland, Belgium, USA and India.
This system is simple and elastic. The money supply can be changed with changes in the percentage of gold reserves. It provides sufficient security because a certain percentage of note issue is supported by gold.
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Still, this system has certain drawbacks. Firstly, It is uneconomical because large quantities of gold reserves have to be kept which cannot be issued for productive purposes. Second, if the gold reserves fall, the reduction in currency in circulation may be more than in proportion to the fall in reserves. This may lead to deflationary tendencies. The opposite may happen when gold reserves increase.’ This system was in vogue in India between 1927 to 1956.
Method # 5. Minimum Reserve System:
Under the minimum reserve system, the central bank is authorised to issue notes up to any extent but it must keep a statutory minimum reserve of gold and foreign securities. India adopted this system of note issue in 1956 after discarding the proportional reserve system. Accordingly, the Reserve Bank of India is required to keep a minimum reserve of Rs. 200 crores. Of this, Rs. 115 crores must be in gold and Rs85 crores in foreign securities.
This system is highly useful for developing countries because they can meet their financial requirements by printing more notes. They can also reduce the money supply to check inflation. It is, therefore, an elastic system. Further, it is very economical because only a small and fixed amount of gold is required to be kept in reserve.
Despite these merits, the minimum reserve system is a dangerous tool in the hands of the monetary authority. It can print any number of notes, thereby creating inflationary pressure within the economy. A corrupt and inefficient government can bring disaster to the economy by excessive printing of notes and thus lose confidence of the people. On the other hand, an efficient and honest administration can transform the economy by a judicious use of this system.
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