INTRODUCTION
- Money is at the centre of every economic transaction and plays a significant role in all economies. In simple terms money refers to assets which are commonly used and accepted as a means of payment or as a medium of exchange or of transferring purchasing power.
- For policy purposes, money may be defined as the set of liquid financial assets, the variation in the stock of which will have impact on aggregate economic activity.
- Money has generalized purchasing power and is generally acceptable in settlement of all transactions and in discharge of other kinds of business obligations including future payments. Anything that would act as a medium of exchange is not necessarily money.
- For example, a bill of exchange may also be a medium of exchange, but it is not money since it is not generally accepted as a means of payment. Money is a totally liquid asset as it can be used directly, instantly, conveniently and without any costs or restrictions to make payments.
- At the fundamental level, money provides us with a convenient means to access goods and services. Money represents a certain value, but currency which represents money does not necessarily have intrinsic value.
- As you know, fiat money has no intrinsic value, but is used as a medium of exchange because the government has, by law, made them “legal tender,” which means that they serve by law as means of payment. In modern days, money is not necessarily a physical item; it may also constitute electronic records.
- Money is, in fact, only one among many kinds of financial assets which households, firms, governments and other economic units hold in their asset portfolios. Unlike other financial assets, money is an essential element in conducting most of the economic transactions in an economy.
FUNCTIONS OF MONEY
Money performs many important functions in an economy.
(i) Money is a convenient medium of exchange or it is an instrument that facilitates easy exchange of goods and services. Money, though not having any inherent power to directly satisfy human wants, by acting as a medium of exchange, it commands purchasing power and its possession enables us to purchase goods and services to satisfy our wants. By acting as an intermediary, money increases the ease of trade and reduces the inefficiency and transaction costs involved in a barter exchange. By decomposing the single barter transaction into two separate transactions of sale and purchase, money eliminates the need for double coincidence of wants. Money also facilitates separation of transactions both in time and place and this in turn enables us to economize on time and efforts involved in transactions.
(ii) Money is an explicitly defined unit of value or unit of account. Put differently, money is a ‘common measure of value’ or ‘common denominator of value’ or money functions as a numeraire. We know, Rupee is the unit of account in India in which the entire money is denominated. The monetary unit is the unit of measurement in terms of which the value of all goods and services is measured and expressed. The value of each good or service is expressed as price, which is nothing but the number of monetary units for which the good or service can be exchanged. It is convenient to trade all commodities in exchange for a single commodity. So also, it is convenient to measure the prices of all commodities in terms of a single unit, rather than record the relative price of every good in terms of every other good. An obvious advantage of having a single unit of account is that it greatly reduces the number of exchange ratios between goods and services. Use of money as a unit of account can encourage trade by making it easier for individuals to know how much one good is worth in terms of another.
A common unit of account facilitates a system of orderly pricing which is crucial for rational economic choices. Goods and services which are otherwise not comparable are made comparable through expressing the worth of each in terms of money. Money is a useful measuring rod of value only if the value of money remains constant. The value of money is linked to its purchasing power. Purchasing power is the inverse of the average or general level of prices as measured by the consumer price index.
(iii) Money serves as a unit or standard of deferred payment i.e money facilitates recording of deferred promises to pay. Money is the unit in terms of which future payments are contracted or stated. However, variations in the purchasing power of money due to inflation or deflation, reduce the efficacy of money in this function.
Like nearly all other assets, money is a store of value. People prefer to hold it as an asset, that is, as part of their stock of wealth. The splitting of purchases and sale into two transactions involves a separation in both time and space. This separation is possible because money can be used as a store of value or store of means of payment during the intervening time. Again, rather than spending one’s money at present, one can store it for use at some future time. Thus, money functions as a temporary abode of purchasing power in order to efficiently perform its medium of exchange function.
Money also functions as a permanent store of value. There are many other assets such as government bonds, deposits and other securities, land, houses etc. which also store value. Despite having the advantages of potential income yield and appreciation in value over time, these other assets are subject to limitations such as storage costs, lack of liquidity and possibility of depreciation in value. Money is the only asset which has perfect liquidity. Additionally, money also commands reversibility as its value in payment equals its value in receipt. All assets other than money lack perfect reversibility in the sense that their value in payment is not equal to their value in receipt. Even financial assets like the riskless government bonds do not command perfect reversibility as their purchase and sale are subject to certain brokerage costs although this may be quite small.The effectiveness of an asset as a store of value depends on the degree and certainty with which the asset maintains its value over time. Hence, in order to serve as a permanent store of value in the economy, the purchasing power or the value of money should either remain stable or should monotonically rise over time.
There are some general characteristics that money should possess in order to make it serve its functions as money. Money should be:
- generally acceptable
- durable or long-lasting
- effortlessly recognizable.
- difficult to counterfeit i.e. not easily reproducible by people
- relatively scarce, but has elasticity of supply
- portable or easily transported
- possessing uniformity; and
- divisible into smaller parts in usable quantities or fractions without losing value
No comments:
Post a Comment