Money: Origins, Types, and Modern Economic Roles
Money: Origin and Types
Commodity money has inherent value equal to its currency unit value.
A. From Commodity to Paper Money
Fiat money has minimal commodity value but is accepted due to public trust and government decree.
B. Money in the Current Financial System
Modern paper money is backed by confidence, not precious metals. Deposit money, like bank accounts, settles debts.
- Checks mobilize money but don’t create it.
- Credit cards are payment methods, not money.
- Bank money is a bank’s debt to depositors, payable on demand.
C. Money in Modern Economies: The Amount of Money
Legal money (coins, banknotes) is issued by a central authority. Bank money includes deposits accepted as payment.
- Overnight deposits: readily available funds.
- Savings deposits: slightly less available.
- Time deposits: fixed-term funds with penalties for early withdrawal.
Liquidity is the ease of converting assets to cash without loss.
Monetary Policy: Monetary Aggregates
Money supply includes cash held by the public and bank deposits.
Monetary aggregates quantify money for policy decisions.
Monetary base includes bank reserves and public cash.
The Demand for Money
A. Functions of Money
- Medium of exchange for transactions.
- Unit of account for pricing and accounting.
- Store of value over time.
The opportunity cost of holding money is the forgone interest from less liquid assets.
Interest is the cost of using money.
B. Demand for Transactions
Higher income and transaction values increase money demand.
Higher interest rates on other assets decrease money demand.
Banks and Money Creation
Financial intermediaries transfer funds and create assets like demand deposits.
Commercial banks accept deposits and lend, holding reserves.
Reserves are assets held to meet depositor claims.
Money Creation: 1 / Reserve Ratio x Deposits
Key players in money creation:
- Monetary authority (e.g., Bank of Spain) creates liquidity.
- Banking system expands money and credit.
- Public decides asset allocation.