Functions of Money
Medium of Exchange: Money serves as a means of exchange in transactions. Individuals use money to purchase and sell things instead of directly exchanging commodities and services. This makes commerce more efficient because it reduces the requirement for a double coincidence of desires, in which both sides in a deal must want what the other possesses.
Unit of Account: Money serves as a standard unit of value that allows people to compare the pricing of various commodities and services. Prices, for example, are represented in terms of a currency (e.g., dollars, euros) to give a standard unit of measurement for value.
Store of Value: Money can be saved or preserved for later use. Unlike perishable items or other types of wealth, money holds its worth throughout time. It enables people to save their money and utilise it in the future.
Standard of Deferred Payment: Money is usable to establish arrangements for future payments. Money is commonly used as the agreed-upon means for settling obligations at a later period in contracts, loans, and financial agreements.
Types of Money
Fiat money: Modern economies primarily use fiat money, which has no intrinsic value but is recognised as legal tender by government edict. Its worth is determined by faith in the government and the currency's stability.
Cryptocurrencies: Digital currencies such as Bitcoin and Ethereum are a relatively new kind of money. They are decentralised and use blockchain technology to provide security and transparency.
Digital and electronic money: In the digital age of today, a large amount of money lives in electronic form, such as bank deposits and digital payment systems like PayPal and credit cards.
Commodity as Money: Physical goods, such as gold, silver, or other precious items, serve as money because they had intrinsic value and are universally accepted.
High-powered money: Cash and its equivalents available to the public and bank deposits are included in high-powered money. Since they are highly liquid, they directly affect the supply of money in an economy.
Bank Reserves: The central bank mandates commercial banks to hold a fixed percentage of deposits as reserves in case of any emergency. Banks lend the excess reserve amount to consumers, increasing money circulation.
Reserve ratio: It is the ratio of cash reserve to deposits, as instructed by the central bank. If the central bank increases the ratio, banks will have to hold more money in reserves, reducing banks’ lending capabilities.
Money held by the public: If people have more liquid cash at home, they will only spend a small portion required. However, if the same cash is deposited in the bank, the supply in the economy will be high.
M0 = Currency notes + coins + bank reserves
M1 = M0 + demand deposits
M2 = M1 + marketable securities + other less liquid bank deposits
M3 = M2 + money market funds
M4 = M3 + least liquid assets
M0 Or Monetary Base: The monetary base is the total quantity of currency in circulation or held in reserve. Money in circulation is defined as everything possessed and utilised by the general population, whereas reserves are commercial bank deposits and any money held in reserves at the central bank.
M1 Money: Money supply includes the most liquid forms of money. That is money in circulation ie Coins and banknotes used in daily transactions. Demandable checks for deposits ie sums kept in checking accounts accessible via debit cards or cheques. Traveller's checks are a type of pre-paid cash that can be used to make purchases. Savings deposits are bank accounts individuals may quickly take money out of ATMs or banks. ie all M0, plus demand deposit and traveller's cheque. M1 focuses on highly liquid assets.
M2 Money: M2 Money Supply is wider, including M1 and additional forms of deposits: Time deposits include certificates of deposit (CDs) and other fixed-term deposits. Money Market Funds: Pooled investments in secure assets, such as short-term government bonds. In short, M2 combines M1 and additional near-money assets.
M3 money: M3 money, often known as 'broad money,' is made up of M2 and money market funds such as mutual funds, repurchase agreements, and commercial papers. M3 contains M2 (currency, demand deposits, and time deposits), as well as longer-term time deposits and money market funds with maturities of more than 24 hours. Essentially, M3 encompasses a broader range of financial products that can be rapidly converted to cash.
M4 money : M4 money supply includes M3 and all other least liquid assets, which are often held outside of commercial banks. M4 extends beyond M3 by encompassing all other least liquid assets, which are often kept outside commercial banks. These assets may not be as easily converted into cash as those in M3. M4 assets comprise less liquid items like bonds and securities.