Understanding the Characteristics and Functions of Money
Money plays a crucial role in modern economies. Here’s a breakdown of its key characteristics and functions:
Characteristics of Money
- Durable: Money must be durable and not easily perishable.
- Transportable: It should be easy to carry, with a high value relative to its weight.
- Divisible: Money must be divisible into smaller units without losing value, facilitating transactions of different sizes.
- Homogeneous: Each unit of money should be identical to others, ensuring consistent value in exchanges.
- Limited Supply: Money must have a limited supply to maintain its economic value.
Types of Money
- Token Money: Has a low intrinsic value as a commodity but maintains its value as a medium of exchange due to faith in the issuing authority.
- Full-bodied Money: Paper certificates backed by equivalent gold deposits. A gold standard exists when an economy uses gold as money or paper money convertible into gold.
- Bank Money: A debt from a bank payable to the depositor upon request, functioning as a medium of exchange.
- Legal Money: Coins or banknotes issued by a monopolizing institution.
Money Supply
The money supply is the sum of cash in the hands of the public (individuals and businesses) plus deposits in banks. Different measures of money supply include:
- M1: Banknotes and coins in circulation, demand deposits.
- M2: M1 plus time deposits (up to two years) and deposits available at notice (up to three months).
- M3: M2 plus repurchase agreements, money market fund shares, money market instruments, and debt securities (up to two years) issued by monetary institutions.
Monetary Base
The monetary base is the sum of bank reserves and cash held by the public, also known as high-powered money.
Functions of Money
- Medium of Exchange: Money is generally accepted for transactions and debt cancellation, eliminating the need for barter.
- Unit of Account: Money serves as a standard for setting prices and keeping accounts.
- Store of Value: Money allows value to be carried over time, acting as a financial asset. The opportunity cost of holding money is the interest sacrificed by not investing in other assets.
Financial Intermediaries
Financial intermediaries transfer funds from lenders to borrowers, creating financial assets like current accounts (deposits). Commercial banks are authorized to accept deposits and meet depositor claims. The cash reserve ratio is the ratio of reserves to deposits.