In the past, money was generally considered to have the following four main functions, which are summed up in a rhyme found in older economics textbooks:
"Money is a matter of functions four, a medium, a measure, a standard, a store." That is, money functions as a medium of exchange, a unit of account, a standard of deferred payment, and a store of value.
However, most modern textbooks now list only three functions, that of medium of exchange, unit of account, and store of value, not considering a standard of deferred payment as a distinguished function, but rather subsuming it in the others.
There have been many historical disputes regarding the combination of money's functions, some arguing that they need more separation and that a single unit is insufficient to deal with them all. One of these arguments is that the role of money as a medium of exchange is in conflict with its role as a store of value:
Its role as a store of value requires holding it without spending, whereas its role as a medium of exchange requires it to circulate.
Others argue that storing of value is just deferral of the exchange, but does not diminish the fact that money is a medium of exchange that can be transported both across space and time.
The term 'financial capital' is a more general and inclusive term for all liquid instruments, whether or not they are a uniformly recognized tender.
Thursday, May 13, 2010
Medium of Exchange
When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange. It thereby avoids the inefficiencies of a barter system, such as the 'double coincidence of wants' problems.
Unit of Account
A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of relative worth and deferred payment, a unit of account is a necessary prerequisite for the formulation of commercial agreements that involve debt. To function as a 'unit of account', whatever is being used as money must be:
* Divisible into smaller units without loss of value; precious metals can be coined from bars, or melted down into bars again.
* Fungible: that is, one unit or piece must be perceived as equivalent to any other, which is why diamonds, works of art or real estate are not suitable as money.
* A specific weight, or measure, or size to be verifiably countable. For instance, coins are often made with ridges around the edges, so that any removal of material from the coin (lowering its commodity value) will be easy to detect.
* Divisible into smaller units without loss of value; precious metals can be coined from bars, or melted down into bars again.
* Fungible: that is, one unit or piece must be perceived as equivalent to any other, which is why diamonds, works of art or real estate are not suitable as money.
* A specific weight, or measure, or size to be verifiably countable. For instance, coins are often made with ridges around the edges, so that any removal of material from the coin (lowering its commodity value) will be easy to detect.
Commercial Bank Money
Commercial bank money or demand deposits are claims against financial institutions that can be used for the purchase of goods and services. A demand deposit account is an account from which funds can be withdrawn at any time by check or cash withdrawal without giving the bank or financial institution any prior notice.
Banks have the legal obligation to return funds held in demand deposits immediately upon demand (or 'at call'). Demand deposit withdrawals can be performed in person, via checks or bank drafts, using automatic teller machines (ATMs), or through online banking.
Commercial bank money is created through fractional-reserve banking, the banking practice where banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder, while maintaining the simultaneous obligation to redeem all these deposits upon demand.
Commercial bank money differs from commodity and fiat money in two ways, firstly it is non-physical, as its existence is only reflected in the account ledges of banks and other financial institutions, and secondly, there is some element of risk that the claim will not be fulfilled if the financial institution becomes insolvent.
The process of fractional-reserve banking has a cumulative effect of money creation by commercial banks, as it expands money supply (cash and demand deposits) beyond what it would otherwise be. Because of the prevalence of fractional reserve banking, the broad money supply of most countries is a multiple larger than the amount of base money created by the country's central bank. That multiple (called the money multiplier) is determined by the reserve requirement or other financial ratio requirements imposed by financial regulators.
The money supply of a country is usually held to be the total amount of currency in circulation plus the total amount of checking and savings deposits in the commercial banks in the country.
Banks have the legal obligation to return funds held in demand deposits immediately upon demand (or 'at call'). Demand deposit withdrawals can be performed in person, via checks or bank drafts, using automatic teller machines (ATMs), or through online banking.
Commercial bank money is created through fractional-reserve banking, the banking practice where banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder, while maintaining the simultaneous obligation to redeem all these deposits upon demand.
Commercial bank money differs from commodity and fiat money in two ways, firstly it is non-physical, as its existence is only reflected in the account ledges of banks and other financial institutions, and secondly, there is some element of risk that the claim will not be fulfilled if the financial institution becomes insolvent.
The process of fractional-reserve banking has a cumulative effect of money creation by commercial banks, as it expands money supply (cash and demand deposits) beyond what it would otherwise be. Because of the prevalence of fractional reserve banking, the broad money supply of most countries is a multiple larger than the amount of base money created by the country's central bank. That multiple (called the money multiplier) is determined by the reserve requirement or other financial ratio requirements imposed by financial regulators.
The money supply of a country is usually held to be the total amount of currency in circulation plus the total amount of checking and savings deposits in the commercial banks in the country.
Commodity Money
Many items have been used as commodity money such as naturally scarce precious metals, conch shells, barley, beads etc., as well as many other things that are thought of as having value. Commodity money value comes from the commodity out of which it is made. The commodity itself constitutes the money, and the money is the commodity.
Examples of commodities that have been used as mediums of exchange include:
gold
silver
copper
rice
salt
peppercorns
large stones
decorated belts
shells
alcohol
cigarettes
cannabis
candy
etc.
These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or Price System economies.
Use of commodity money is similar to barter, but a commodity money provides a simple and automatic unit of account for the commodity which is being used as money. Although some gold coins such as the Krugerrand are considered legal tender, there is no record of their face value on either side of the coin. The rationale for this is that emphasis is laid on their direct link to the prevailing value of their fine gold content.
American Eagles are imprinted with their gold content and legal tender face value.
Examples of commodities that have been used as mediums of exchange include:
gold
silver
copper
rice
salt
peppercorns
large stones
decorated belts
shells
alcohol
cigarettes
cannabis
candy
etc.
These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or Price System economies.
Use of commodity money is similar to barter, but a commodity money provides a simple and automatic unit of account for the commodity which is being used as money. Although some gold coins such as the Krugerrand are considered legal tender, there is no record of their face value on either side of the coin. The rationale for this is that emphasis is laid on their direct link to the prevailing value of their fine gold content.
American Eagles are imprinted with their gold content and legal tender face value.
Store of Value
A recognized form of exchange can be a form of money or currency, a commodity like gold, or financial capital. To act as a store of value, these forms must be able to be saved and retrieved at a later time, and be predictably useful when retrieved.
Storage of value is one of several distinct functions of money. The other functions are the standard of deferred payment, which requires acceptability to parties owed a debt, and the unit of account, which requires fungibility so accounts in any amount can be readily settled. It is also distinct from the medium of exchange function which requires durability when used in trade and to minimize fraud opportunities.
1. With money being a storage of value was the start of monetary inflation cycles where the under and over abundance of market goods can lead to price instability.
2. Common alternatives that act as stores of value are:
* real estate - actual deeds in protectible land
* gold - once the basis of the gold standard
* silver - once the basis of the silver standard
* precious stones, and precious metals
* collectibles, e.g. original art by a famous artist or antiques
* livestock (see African currency)
* stock
While these items may be inconvenient to trade daily or store, and may vary in value quite significantly, they rarely or never lose all value. This is the point of any store of value, to impose a natural risk management simply due to inherent stable demand for the underlying asset. It need not be a capital asset at all, merely have economic value that is not known to disappear even in the worst situation. In principle, this could be true of any industrial commodity, but gold and precious metals are generally favored because of their demand and rarity in nature, which reduces the risk of devaluation associated with increased production and supply.
Storage of value is one of several distinct functions of money. The other functions are the standard of deferred payment, which requires acceptability to parties owed a debt, and the unit of account, which requires fungibility so accounts in any amount can be readily settled. It is also distinct from the medium of exchange function which requires durability when used in trade and to minimize fraud opportunities.
1. With money being a storage of value was the start of monetary inflation cycles where the under and over abundance of market goods can lead to price instability.
2. Common alternatives that act as stores of value are:
* real estate - actual deeds in protectible land
* gold - once the basis of the gold standard
* silver - once the basis of the silver standard
* precious stones, and precious metals
* collectibles, e.g. original art by a famous artist or antiques
* livestock (see African currency)
* stock
While these items may be inconvenient to trade daily or store, and may vary in value quite significantly, they rarely or never lose all value. This is the point of any store of value, to impose a natural risk management simply due to inherent stable demand for the underlying asset. It need not be a capital asset at all, merely have economic value that is not known to disappear even in the worst situation. In principle, this could be true of any industrial commodity, but gold and precious metals are generally favored because of their demand and rarity in nature, which reduces the risk of devaluation associated with increased production and supply.
Sunday, March 28, 2010
Money Impact On Other Variables
High growth rates in nominal money quantity, if clearly exeeding nominal GDP rates, can exert inflationary pressures.
If economic agents base their expectations about future inflation on the money quantity, one would expect the present inflation rate boosted by money quantity growth. But this is dependent on how present prices are influenced by mere expectations.
In many empirical instances, a certain increase of money quantity have turned out to be conducive to growth in real GDP.
Many short run acceleration or deceleration of the money quantity remain without any noticeable effects on other variables.
Long-term trends
Nominal money quantity has always grown, apart from few pathological events. Real money quantity has grown most of the time.
In hyperinflation episodes, real quantity of money sharply fell and remained at low levels for a long time.
Business cycle behaviour
Nominal money quantity is usually pro-cyclical, sometimes leading real GDP peaks.
If economic agents base their expectations about future inflation on the money quantity, one would expect the present inflation rate boosted by money quantity growth. But this is dependent on how present prices are influenced by mere expectations.
In many empirical instances, a certain increase of money quantity have turned out to be conducive to growth in real GDP.
Many short run acceleration or deceleration of the money quantity remain without any noticeable effects on other variables.
Long-term trends
Nominal money quantity has always grown, apart from few pathological events. Real money quantity has grown most of the time.
In hyperinflation episodes, real quantity of money sharply fell and remained at low levels for a long time.
Business cycle behaviour
Nominal money quantity is usually pro-cyclical, sometimes leading real GDP peaks.
Determinants of Money
Narrowly-defined money is heavily influenced by central banks.
Instead, depositors, banks, financial and public institutions play a crucial role for broad money aggregates.
International money quantity, i.e. the national quantities of money converted in one common currency at the prevailing nominal exchange rates, is completely out of control.
With respect to the general economic climate, a booming economy usually exhibits a high growth of money quantity. By contrast, in hyperinflation, real money is drastically squeezed.
Instead, depositors, banks, financial and public institutions play a crucial role for broad money aggregates.
International money quantity, i.e. the national quantities of money converted in one common currency at the prevailing nominal exchange rates, is completely out of control.
With respect to the general economic climate, a booming economy usually exhibits a high growth of money quantity. By contrast, in hyperinflation, real money is drastically squeezed.
Roles of Money
Money is whatever can be used in order to settle payments. Nowadays, the most common kind of money are current accounts in the banks.
Cash, a self-evident component of money, has a short life out of the banks. Within few days is spent, for example in a shop, and the shopkeeper brings urgently cash back to a bank.
1. it is the medium of exchange that settle payments. People accept money in exchange of goods and services. Nothing is owed anymore.
2. money is the most common medium of account, i.e. it is the good some quantity of which serves as unit of account for prices. Prices are expressed using monetary expressions.
3. money is a store of value over time and across people, firms, countries. Selling things gives money that can be saved and spent in the future for many different goods and services. However, there exist other financial instruments - and even goods - that can serve as a store of value as well.
Cash, a self-evident component of money, has a short life out of the banks. Within few days is spent, for example in a shop, and the shopkeeper brings urgently cash back to a bank.
1. it is the medium of exchange that settle payments. People accept money in exchange of goods and services. Nothing is owed anymore.
2. money is the most common medium of account, i.e. it is the good some quantity of which serves as unit of account for prices. Prices are expressed using monetary expressions.
3. money is a store of value over time and across people, firms, countries. Selling things gives money that can be saved and spent in the future for many different goods and services. However, there exist other financial instruments - and even goods - that can serve as a store of value as well.
Money Composition
Money quantity is the nominal value of particularly "liquid" financial instruments in an economy. "Liquidity" means that an asset is easy to sell in any moment with small or no losses in respect to nominal price
There exist a few definitions of money quantity, some broader than others, i.e. including a wider range of financial instruments.
For the following definitions, a series of simplification has been taken to keep things easy. Moreover, there exist significant international differences in definitions, especially for broader money definitions (M2 and M3).
The narrowest definition of money, the monetary base comprehends only cash outside banks plus bank reserves, the latter including both cash reserves held by banks and banks' deposits at the central bank.
Larger than the monetary base, M1 comprehends cash and current accounts in banks.
M2 is M1 plus the savings account.
M3 is M2 plus other liquid liabilities of monetary financial institutions.
Thus, although a largely accepted image of money doesn't associate it to interest-bearing, some definitions do comprehend interest-bearing assets.
A crucial distinction is between nominal and real quantity of money, the latter being equal to the former divided by price level. In this way, real money dynamics becomes dependent on inflation.
This is particularly important, since inflation, in its turn, is dependent on nominal and real quantity of money, too.
There exist a few definitions of money quantity, some broader than others, i.e. including a wider range of financial instruments.
For the following definitions, a series of simplification has been taken to keep things easy. Moreover, there exist significant international differences in definitions, especially for broader money definitions (M2 and M3).
The narrowest definition of money, the monetary base comprehends only cash outside banks plus bank reserves, the latter including both cash reserves held by banks and banks' deposits at the central bank.
Larger than the monetary base, M1 comprehends cash and current accounts in banks.
M2 is M1 plus the savings account.
M3 is M2 plus other liquid liabilities of monetary financial institutions.
Thus, although a largely accepted image of money doesn't associate it to interest-bearing, some definitions do comprehend interest-bearing assets.
A crucial distinction is between nominal and real quantity of money, the latter being equal to the former divided by price level. In this way, real money dynamics becomes dependent on inflation.
This is particularly important, since inflation, in its turn, is dependent on nominal and real quantity of money, too.
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