The definition and forms of money

Money is an item that individuals and businesses use to purchase and sell products and services, while also serving additional roles in the economy.

Different forms of money

• Bank notes and coins (cash) - These are physical forms of money mainly used for smaller transactions.
• Money in bank deposits - This is the primary type of money in modern economies, moved through methods like direct debits, credit cards, or smartphone apps.

Cryptocurrencies

Cryptocurrencies are digital or electronic forms of money that enable direct payments between people without involving traditional banks.

Key features of cryptocurrencies:

• They are not controlled by central banks.
• Bitcoin, launched in 2009, is the most common cryptocurrency.
• People can obtain bitcoins by accepting them as payment, purchasing them on specialised websites, or through mining, which involves performing tasks to support the bitcoin network.
• The value of cryptocurrencies is set by supply and demand, leading to high levels of price volatility.
• Their use as money is restricted because they are not widely accepted.

The functions of money

Money performs several essential roles that make economic transactions easier and more efficient.

Key functions of money

• Medium of exchange - Money allows people to sell items and services, then use the received funds to buy other things. This avoids the need for a double coincidence of wants, where two parties must each have exactly what the other desires. For example, a furniture maker can sell chairs to one customer and use the money to purchase wood from a different supplier.
• Store of value - Money lets individuals and firms save earnings from sales for later spending, preserving purchasing power over time.
• Unit of account - Money provides a way to measure and compare the worth of different goods and services by expressing their prices in a common unit. For instance, if a laptop costs £800 and a book costs £20, the laptop is worth 40 times as much as the book.
• Standard of deferred payment - Money enables borrowing, lending, and future transactions by setting clear terms for repayment. For example, a business might borrow funds now and agree to repay a specific amount in three years, or arrange to purchase raw materials on credit for delivery next year.

The characteristics of money

For an item to function effectively as money, it must possess certain qualities that make it practical and trustworthy in everyday use.

Essential characteristics of money

• Generally acceptable - This is the most vital feature; if people do not trust or accept something as payment, for savings, or for future deals, it cannot serve as money. In some nations facing extreme inflation, residents may switch to foreign currencies when they lose faith in their own.
• Recognisable - Money must be easy to identify as genuine. Central banks design notes and coins with unique features to distinguish them.
• Portable - It should be simple to transport. Notes are lightweight, coins are not overly heavy, and digital transfers require no physical movement.
• Divisible - Money needs to be split into various values to suit different transaction sizes, such as through different denominations of notes and coins.
• Homogeneous - All units of the same type must be identical in quality and value. Historically, when governments reduced the metal content in coins, people valued the altered ones less than unchanged versions they kept.
• Limited in supply - An endless supply would make money worthless and unacceptable.
• Not easy to counterfeit - Money must be hard to fake to maintain its value; central banks add security elements to prevent forgery.

The money supply and its measures

The money supply refers to the overall quantity of money available in an economy, including currency in use and certain types of deposits.

Reasons for measuring the money supply

• It provides insights into patterns in overall demand for goods and services.
• It helps assess the condition of financial systems.
• It guides decisions on monetary policy, such as interest rate adjustments.

Measuring the money supply can be challenging because it is not always clear which items to count.

Measures of the money supply

• Narrow money (monetary base) - This focuses on money used directly for transactions and includes notes and coins in circulation, cash held by banks, and reserves that commercial banks keep at the central bank.
• Broad money - This builds on narrow money by adding elements linked to saving, such as funds in savings accounts that act as a store of value.