Understanding Money, Monetary Policy, and Financial Systems

Evolution and Conditions of Money

Money is defined as a universally accepted medium of payment. Historically, items such as salt and grain served this purpose. To function effectively, money must meet specific criteria:

• Scarcity and stability: Maintains value over time.
• Durability: Resistant to deterioration.
• Portability: Easy to transport and transfer.
• Homogeneity: Uniformity in units.

Functions of Money

• Medium of exchange: Facilitates the trade of goods and services, replacing barter systems.
• Unit of account: Allows for the pricing of goods and services as multiples of a standard unit.
• Store of value: Enables the accumulation of wealth over time.

Types of Money

• Commodity money: Has intrinsic value equal to its monetary value.
• Metal money: Based on precious metals.
• Convertible paper money: Redeemable for precious metals.
• Fiat money: Value is based on public trust. This includes:
  • Cash: Bills and coins.
  • Bank money: Deposits in banks and financial institutions.

Monetary Base and Supply

• Monetary Base: (e + θ) · D
• Monetary Supply: (e + 1) · D

Theory of Inflation

Monetarist Perspective

Inflation is linked to the monetary supply. As more money is created, its value decreases, causing product prices to rise.

Keynesian Perspective

Inflation is related to effective demand. When the economy reaches full employment and production cannot increase to meet rising demand, prices tend to grow.

Expansionary Monetary Policies

• Buying bonds from commercial banks.
• Decreasing the reference interest rate.
• Decreasing bank reserve requirements.

The Financial System

The financial system is a group of institutions that provide resources to the economic system to support its activities. Its main function is to act as a financial intermediary between those who wish to save and earn interest, and those who need financing and are willing to pay interest.

Banks as Financial Intermediaries

Banks mediate between savers and borrowers, create money, and provide security and management services (e.g., invoices, payments, taxes, salaries, and currency exchange). Key conditions between savers and borrowers include terms, interest rates, risk, and liquidity.

The Stock Market

The stock market is where financial titles and stocks are traded. Shares represent property titles, making the holder a partial owner of the company.