CHAPTER 44: Money and Banking
DEFINITION, FUNCTIONS AND CHARACTERISTICS OF MONEY
Money can be defined as anything which is generally acceptable as a means of payment.
Before the development of money, barter was used. This involves the direct exchange of goods
and services without the use of any monetary mechanism.
Barter had a number of distinct disadvantages:
1. It required a double coincidence of wants, i.e. one person offering a good or service needs to
find someone who wants that good or service and that person also needs to be offering
something in exchange that the seller wants.
2. It was often difficult to compare the value of different goods and services.
3. The products may be indivisible, e.g. in the case of animals.
4. The products may be difficult to store while a seller is looking for an appropriate buyer.
These various disadvantages of barter meant that economies moved towards the
development of money which would avoid the direct exchange of goods and services.
Although money has largely replaced barter, it is still necessary to establish what is, and what
is not, money:
1. Cash: the most obvious form of money is cash, whether in the form of notes or coins.
2. Legal tender: some money may only be acceptable in transactions up to a certain amount
and this is referred to as legal tender; this means that it must be accepted legally as a means
of payment.
3. Bank deposits: much money is in the form of money deposited in banks, building societies,
credit unions and other financial institutions; these monetary deposits can be in current
accounts or various forms of savings account.
4. Near money: near money, or quasi money as it is sometimes called, refers to an asset that is
immediately transferable into money and so can be used to settle some, but not all, debts.
Near money, therefore, is able to fulfill some of the functions of money, but not all of them.
For example, it cannot be used as a medium of exchange.
5. Liquidity: the ability to turn an asset into cash refers to its liquidity. Cash is the most liquid
form of asset. The more liquid an asset, the easier it is to convert it into money.
6. Cheque: it is important to know not only what money is, but also what it is not. For example,
a cheque is sometimes believed to be a form of money, but this is incorrect as a cheque is
simply a means of payment and is not actually a form of money.
FUNCTIONS OF MONEY
Money is said to perform four essential functions in an economy:
1. A medium of exchange. A very important function of money is that it operates effectively as a
means of exchange. Money is generally accepted as a means of payment for goods and
services. This is the great advantage of money over barter, i.e. it overcomes the problems
, associated with the need to have a double coincidence of wants between two people.
2. A measure of value or unit of account. This function of money can either be described as a
measure of value or as a unit of account. This is the idea that money enables the value of
different goods and services to be compared. The direct exchange of goods and services in a
barter system made it very difficult to give a valuation of the different products being traded.
This function of money makes it possible to compare the value of different goods and
services.
3. A standard for deferred payment. Money enables people to borrow money and pay it back
at a later date. This encourages the provision of credit and so acts as an incentive to trade.
Buyers are able to consume goods and services immediately, but the payment can be spread
over a period of time. This was a major limitation of the barter system.
4. A store of value or wealth. A final function of money is that it enables wealth to be stored in
the form of money. Compared to the barter system, money does not physically deteriorate
and it is usually not expensive to store it, although this function of money does face the
problem of a possible deterioration in its value if there is a situation of inflation in an
economy as inflation erodes the value or purchasing power of a given sum of money over a
period of time.
Money has a number of distinctive characteristics and these are outlined in Table below:
DEFINITION OF MONEY SUPPLY
The money supply is the total amount of money in an economy at any one time. It includes
notes and coins and also any deposits, such as current accounts in banks, which can be
quickly converted into cash.
Today more and more transactions are done using cheques, debit cards, credit cards and
electronic bank transfers. It is usual, therefore, to distinguish between narrow money and
broad money although there is no completely agreed definition of either between countries
or economists. Narrow money is sometimes referred to as M0 or M1 and broad money as
M3 or M4.
Narrow definitions of money include only items that can be spent directly, such as cash and
current accounts in banks (since they can be spent directly by using cheques or debit cards).
Broad definitions of money also include various items such as deposit and savings accounts in
banks that cannot be spent directly, but which can nevertheless be readily converted into
cash. Hence, broad measures may include items that are not liquid.
Liquidity refers to the ease with which an asset can be spent. Cash is the most liquid asset, as
it can be used for transactions. However, if you are holding funds in a savings account
whereby you must either give notice of withdrawal or forfeit some return to withdraw it
instantly, then such funds are regarded as being less liquid, as they cannot costlessly or
instantly be used for transactions.
Narrow measures focus on items which are used primarily as means of exchange while broad
measures include items which are used not only as a means of exchange but also as a store of
value.
DEFINITION, FUNCTIONS AND CHARACTERISTICS OF MONEY
Money can be defined as anything which is generally acceptable as a means of payment.
Before the development of money, barter was used. This involves the direct exchange of goods
and services without the use of any monetary mechanism.
Barter had a number of distinct disadvantages:
1. It required a double coincidence of wants, i.e. one person offering a good or service needs to
find someone who wants that good or service and that person also needs to be offering
something in exchange that the seller wants.
2. It was often difficult to compare the value of different goods and services.
3. The products may be indivisible, e.g. in the case of animals.
4. The products may be difficult to store while a seller is looking for an appropriate buyer.
These various disadvantages of barter meant that economies moved towards the
development of money which would avoid the direct exchange of goods and services.
Although money has largely replaced barter, it is still necessary to establish what is, and what
is not, money:
1. Cash: the most obvious form of money is cash, whether in the form of notes or coins.
2. Legal tender: some money may only be acceptable in transactions up to a certain amount
and this is referred to as legal tender; this means that it must be accepted legally as a means
of payment.
3. Bank deposits: much money is in the form of money deposited in banks, building societies,
credit unions and other financial institutions; these monetary deposits can be in current
accounts or various forms of savings account.
4. Near money: near money, or quasi money as it is sometimes called, refers to an asset that is
immediately transferable into money and so can be used to settle some, but not all, debts.
Near money, therefore, is able to fulfill some of the functions of money, but not all of them.
For example, it cannot be used as a medium of exchange.
5. Liquidity: the ability to turn an asset into cash refers to its liquidity. Cash is the most liquid
form of asset. The more liquid an asset, the easier it is to convert it into money.
6. Cheque: it is important to know not only what money is, but also what it is not. For example,
a cheque is sometimes believed to be a form of money, but this is incorrect as a cheque is
simply a means of payment and is not actually a form of money.
FUNCTIONS OF MONEY
Money is said to perform four essential functions in an economy:
1. A medium of exchange. A very important function of money is that it operates effectively as a
means of exchange. Money is generally accepted as a means of payment for goods and
services. This is the great advantage of money over barter, i.e. it overcomes the problems
, associated with the need to have a double coincidence of wants between two people.
2. A measure of value or unit of account. This function of money can either be described as a
measure of value or as a unit of account. This is the idea that money enables the value of
different goods and services to be compared. The direct exchange of goods and services in a
barter system made it very difficult to give a valuation of the different products being traded.
This function of money makes it possible to compare the value of different goods and
services.
3. A standard for deferred payment. Money enables people to borrow money and pay it back
at a later date. This encourages the provision of credit and so acts as an incentive to trade.
Buyers are able to consume goods and services immediately, but the payment can be spread
over a period of time. This was a major limitation of the barter system.
4. A store of value or wealth. A final function of money is that it enables wealth to be stored in
the form of money. Compared to the barter system, money does not physically deteriorate
and it is usually not expensive to store it, although this function of money does face the
problem of a possible deterioration in its value if there is a situation of inflation in an
economy as inflation erodes the value or purchasing power of a given sum of money over a
period of time.
Money has a number of distinctive characteristics and these are outlined in Table below:
DEFINITION OF MONEY SUPPLY
The money supply is the total amount of money in an economy at any one time. It includes
notes and coins and also any deposits, such as current accounts in banks, which can be
quickly converted into cash.
Today more and more transactions are done using cheques, debit cards, credit cards and
electronic bank transfers. It is usual, therefore, to distinguish between narrow money and
broad money although there is no completely agreed definition of either between countries
or economists. Narrow money is sometimes referred to as M0 or M1 and broad money as
M3 or M4.
Narrow definitions of money include only items that can be spent directly, such as cash and
current accounts in banks (since they can be spent directly by using cheques or debit cards).
Broad definitions of money also include various items such as deposit and savings accounts in
banks that cannot be spent directly, but which can nevertheless be readily converted into
cash. Hence, broad measures may include items that are not liquid.
Liquidity refers to the ease with which an asset can be spent. Cash is the most liquid asset, as
it can be used for transactions. However, if you are holding funds in a savings account
whereby you must either give notice of withdrawal or forfeit some return to withdraw it
instantly, then such funds are regarded as being less liquid, as they cannot costlessly or
instantly be used for transactions.
Narrow measures focus on items which are used primarily as means of exchange while broad
measures include items which are used not only as a means of exchange but also as a store of
value.
