Money: Types, Functions, and Economic Supply

Money and Its Functions

Money is any medium of exchange and payment generally accepted by society.

Commodity Money

The most primitive form of money is commodity money, i.e., goods which, in addition to their own use-value, are also used as a medium of payment.

For goods to function as money, they must be easily transportable, durable, divisible into parts, homogeneous, and possess intrinsic value.

Paper Money

The advent of paper money originated with goldsmiths who guarded precious and valuable items. Depositors would entrust their gold or jewelry to these goldsmiths, who, in turn, issued certificates (paper receipts) guaranteeing their return at any time.

These receipts, surrendered in exchange for deposited metal, became the first banknotes. For their convenience, most purchases were made using these notes, and their conversion into gold was rarely requested.

Fiat Money

Fiat money is currency whose value is based on government decree (fiat) and the trust placed in the issuing authority.

Functions of Money

• Medium of Exchange: Money acts as an intermediary that facilitates trade and specialization in production.
• Store of Value: Money serves as a useful store of value, allowing individuals to preserve wealth over time.
• Unit of Account (or Measure): Money provides a common measure, allowing us to compare and measure the value of goods and services.

Money Supply Components

There are several classes of money that contribute to the overall money supply:

• Cash Held by the Public: Consisting of physical notes and coins held by individuals and businesses outside of banks.
• Money Deposited in Banks: For convenience and safety, most people keep their money deposited in banks. These deposits can be categorized as:
  • Demand Deposits (Current Accounts): These offer immediate availability and are typically accessed via checks or debit cards.
  • Savings Deposits (Savings Accounts): These have lower availability than demand deposits and generally do not allow the direct use of checks.
  • Time Deposits: The depositor agrees not to withdraw the funds for a specified period, often in exchange for higher interest rates.
• Quasi-Money: This includes highly liquid financial assets such as promissory notes, Treasury bills, or similar marketable securities. They can be converted into cash very quickly and with minimal risk.

Defining the Money Supply

The money supply, or the total quantity of money circulating in an economy, is generally defined as the sum of currency held by the public (notes and coins) and bank deposits.