Functions of money
Money is a collection of assets in an economy that people are regularly willing to use as a means of payment to buy and sell goods and services. Money is generally accepted as payment for goods and services and payments of debts, such as taxes, in a given coin try or socio-economic context [1]. Throughout history, different objects have been used as money. Metal pieces such as gold and silver were widely used because they keep well and are easy to transport. Gold and silver also have an intrinsic value, as they can be used for jewellery. Today, it is much more common for money to have no intrinsic value, such as banknotes. Money with no intrinsic value is known as fiat money. People accept money because they are confident that they will be able to use it in other transactions. Most of the time we believe that the function of money is basically to give us purchasing power and economic stability, however, money has three main functions, it acts as [2] :
- Medium of payment or exchange
- Deposit or store of value
- Unit of account
Money vs. Currency
Money and currency are two terms that can easily be confused but which are equivalent to different realities.
Money is traditionally defined as an asset that fulfils the following three functions in a society, which are explained below: store of value, medium of exchange, and unit of account. Therefore money when a good appears in an economy: it is capable of serving as a store of value; it is used by citizens as a medium of exchange, and; it is the common unit of account for pricing all other goods in that economy. Thus, the necessary basis for a commodity to be money is its ability to function as a store of value [3].
Currency is the instrument used as money based on a given law. In other words, the government imposes under its jurisdiction, in its territory, that a certain type of monetary instrument fulfils the legal function of money. Such an instrument usually takes the form of coins and banknotes, but may be referred to generically as currency.
In conclusion, while money is a commodity that fulfils the necessary functions, the currency is an instrument that becomes money based on a law that so provides.
Medium of Payment or Exchange
The primary function of money is to facilitate exchange as a generally accepted conventional good guaranteed by the state. Consists of the use of money to carry out any kind of transaction, thus facilitating the exchange of goods, products, and services. Money serves as a medium of exchange to avoid the inefficiencies of a barter system. When a good is required for the sole purpose of using it to be exchanged for other things, it possesses this property. In addition, money must be light and easy to store and transport.
An example of this function would be when a person approaches a shop to buy a product and approaches the cashier to pay for it. As soon as the payment is handled, this function is triggered because an exchange, in this case of money, is being made to obtain something [4].
Store or Deposit of Value
When an asset is required to retain its market value for future exchange, then it is said to be used as a store or deposit of value. This function consists of being able to buy something in the future. Money can remain stable over time, allowing a person who has capital today to invest in the coming months, or even years. Then the money received from today´s sales can be used next week to buy other goods or services. This allows savings, investment, borrowing, etc. Money is a store of value but not the only one; any asset that maintains its purchasing power over time will serve as a store of value [5].
The exchange is divided into two parts [6] :
- On the one hand, individuals carry out sales transactions (exchange goods and services for money).
- On the other hand, they carry out purchase transactions (money for services or goods).
This implies disaggregation of not only material but also temporal exchange. In other words, the individual who has obtained money possesses purchasing power that he will be able to use at the time he deems appropriate in the future.
Unit of account
Another basic function of money is as a unit of account because it determines the price of any good in terms of a quantity of money. When the value of an asset is frequently used to measure and compare the value of other assets or when its value is used to denominate debts, the asset is said to possess this property.
Money expresses in certain units the values (prices) that things already have, thus making it easier to make economic calculations. That is, as a unit of measurement to express the value of goods and services, and thus to establish a scale of what is cheap and what is expensive. It also allows savings, debts, etc. to be expressed in common terms [7][8].
Additional Function
According to authors such as LeRoy and Vanhoose, they attribute to money an additional function as a pattern of deferred payments. This function of money takes place when people enter into contracts that require future payments and specify that these payments are to be made in monetary terms. Debts are expressed in terms of money [9].
Other Opinions
However, authors such as Piégay and Rochon consider that although money is claimed to have the basic functions described above, from both an empirical and a theoretical point of view, one or even two of these functions have been considered more important, and what is considered money rarely fulfils all three functions.
For example, based on statistical measures of money, a narrow monetary aggregate such as M1 largely fulfils the function of a medium of exchange (and a means of payment) but is a mediocre store of wealth (since it yields little or no interest). A broader aggregate, such as M2 minus M1, may constitute a good store of wealth but is not itself a medium of exchange (or a means of payment). The broader aggregate M2 is a collection of different forms of deposits, some of which fulfil the function of a medium of exchange while others fulfil the function of a store of wealth [10].
Footnotes
- ↑ Mishkin F. (2007), pp 43-44.
- ↑ Mishkin F. (2007), pp 44-47.
- ↑ Mishkin F. (2007), pp 43-48.
- ↑ Krugman, P., & Wells, R. (2007), p. 323.
- ↑ Krugman, P., & Wells, R. (2007), p. 323.
- ↑ Gregory Mankiw, N. (2021), p. 642.
- ↑ Krugman, P., & Wells, R. (2007), p. 323.
- ↑ Mishkin F. (2007), pp 44-47.
- ↑ LeRoy Miller, R., & VanHoose, D. (2004), pp. 67-68.
- ↑ Piégay, P., & Rochon LP. (2007), p. 81.
| Functions of money — recommended articles |
| Trade exchange — Barter agreement — Fiduciary money — Value added tax — Rate base — Ijarah — Bankers lien — Implicit interest rate — Depreciation vs. amortization |
References
- Gregory Mankiw, N. (2021). Principles of Economic. Cenage Learning Editores.
- Krugman, P., & Wells, R. (2010). Macroeconomics. Worth Publishers.
- LeRoy Miller, R., & VanHoose, D. (2004). Macroeconomics: Theories, Policies, and International Applications. Thomson South-Western.
- Mishkin F. (2007). The Economic of Money, Banking and Financial Markets. Fourth Canadian Edition.
- Piégay, P., & Rochon LP. (2007). Teorías Monetarias Poskeynesianas. Ediciones AKAL.
Author: Idoia Arregi
