Money and Banking
Functions and measurement of money. The process of
credit creation. The relationship between central
bank and the commercial banks, The demand for money
and the rate of interest.
What is the 'money supply', and what determines its
rate of expansion?
By and large, money is anything that serves as a medium of exchange,
unit of account, and store of value. Therefore, "anything" meeting
the three criteria can serve as money. (This explains why money can
be goold, silver, copper, beaver skins, salt, shells, cigarettes, etc.)
The main concept implicit here is that the use of money simplifies
and therefore increases market transactions. Money also prevents wasting
time that can be devoted to production, thereby promoting economic
growth by increasing a nation's production possibilities (from
I. B. Tucker, III, "Survey of Economics", West Publishing Company, 1995)
MONEY AS A MEDIUM OF EXCHANGE
The most important function of money is to serve as a medium of exchange
because it speeds up transactions removing the problem present in the
act of bartering: coincidence of wants (i.e. I want what you offer and
you want what I offer, let us barter our products then). If socially
agreed, every person is willing to accept money in payment, rather than
goods and services. In short, money increases trade by providing a much
more convenient method of exchange than a cumbersome barter system.
More generally it can be said that money make more efficient the sharing
of goods and services in a non-capitalist society.
MONEY AS A UNIT OF ACCOUNT
Unit of account is the function of money to provide a common measurement
of the relative value of goods and services. Without unit of money
(i.e. sterling pound, U.S. dollar, peso, escudo) there is no common
denominator. The relative value of goods and services is the outcome
of the relative value of the inputs necessary to produce the different
goods and services.
MONEY AS A STORE OF VALUE
Store of value is the ability of money to hold value over time, as an
outcome of a social consensus on what is chosen as money. More
technically defined "money is a useful mechanism for transforming income
in the oresent into future purchases" (assuming no inflation, then,
money stores value -if inflation is present, the value stored with
decrease mirroring the rate of inflation).
The key property of money is that it is immediately 'available' to
spend in exchange for goods and services without any additional expense.
This property is called "liquidity". From here then, one can say that
money 'is completely liquid'. This from comparing with other assets that
also serve as stores of value such as real assets (gold or real estate)
or paper assets (stocks or bonds). These assets also serve as stores of
value, but liquidating (selling) each often involves expenses, such as
brokerage fees, and time delays. Thus, "money is the most liquid form
of wealth because it can be spent directly in the marketplace".
BASIC MONEY-SUPPLY DEFINITIONS
The most narrowly defined money supply is called M1. This money
definition measures purchasing power inmmediately available to the
public without borrowing or having to give notice.
Thus, M1 is the aggregate of currency plus any method to convert
money deposits to currency "on demand".
Currency includes coins and banknotes
Money deposits include bank accounts and credit cards
M2 is equal to M1 plus saving deposits and short-term deposits.
M3 is equal to M2 plus long-term deposits
From the above definitions (which vary slightly from country to country)
is clear that M1 is more liquid than than M2 or M3
THE ROLE OF THE BANKS
There are two types of banks: the central banks and the commercial
banks (including financial institutions).
The central bank controls the money supply within the national
In Britain, the central bank is called Bank of England, in Japan is
the Bank of Japan, and in the United States the Federal Reserve.
The central bank regulates, supervises, and is responsible for
policies concerning money. Thus, it has a central role in regulating
money inflation in the domestic economy, which, also, has an enormous
impact on the economy's performance.
The following are the accepted task of a central bank:
1) controlling the money supply
2) clearing checks
3) supervising and regulating banks
4) maintaining and circulating currency
5) maintaining national reserves of gold and foreign currencies