## Money: At the Center of Transactions

## Source details

**Canonical URL:** [Money: At the Center of Transactions](https://www.imf.org/en/publications/fandd/issues/series/back-to-basics/money)

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## Bibliographic details
- Authors: Ceyda Oner, Irena Asmundson
- Published: July 15, 2018

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### What money is and its core functions
- Money can serve as:
  - store of value, which means people can save it and use it later—smoothing their purchases over time;
  - unit of account, that is, provide a common base for prices; or
  - medium of exchange, something that people can use to buy and sell from one another.
- Practical contrast with barter:
  - Without money, economies revert to barter, requiring a direct coincidence of wants (e.g., a car mechanic needing to find a farmer who needs car repairs).
  - Money eliminates the need to find a particular trading partner and enables specialization, increasing production and demand for transactions and, hence, demand for money.

### Historical forms of money and why some items served better than others
- Many items have been used as money: cowry shells, barley, peppercorns, mobile phone minutes in developing economies, gold, and silver.
- Desirable attributes that made precious metals effective money:
  - durable store of value;
  - stable unit of account;
  - convenient medium of exchange;
  - limited supply and high replacement cost;
  - easily divisible into standardized units and portable.
- Limitations of other goods as money:
  - perishability (e.g., strawberries);
  - difficulty of divisibility and standardization;
  - alternative consumption value sets a floor for worth (e.g., barley or peppercorns could be consumed).

### Transition to fiat money and its implications
- Evolution:
  - Deposit of precious metals at banks led to paper claims on deposits.
  - When the paper claim was delinked from the metal, fiat money was born.
- Characteristics of fiat money:
  - materially worthless but has value because people collectively agree to ascribe value to it;
  - for government-issued currency, tax requirements create a guaranteed source of demand;
  - for other forms (such as cryptocurrencies), value depends on collective belief.
- Policy dilemma with fiat money:
  - Governments face a temptation to issue money to finance spending, risking inflation.
  - Printing too much money can erode trust and lead to hyperinflation if expectations are not managed.
  - To limit this temptation, most countries delegate monetary issuance decisions to independent central banks that do not transfer funds to the government to finance its spending.
- Note: Most money today is in the form of bank deposits rather than paper currency.

### How money is measured (HOW MONEY IS MEASURED)
- Official measurement: broad money, encompassing everything that provides a store of value and liquidity.
- Liquidity definition: the extent to which financial assets can be sold at close to full market value at short notice (easily converted into another form of money, such as cash).
- Components that the IMF (2000) says can be counted as broad money:
  - National currencies (generally issued by the central government).
  - Transferable deposits, which include demand deposits (transferable by check or money order); bank checks (if used as a medium of exchange); traveler’s checks (if used for transactions with residents); and deposits otherwise commonly used to make payments (such as some foreign-currency deposits).
  - Other deposits, such as nontransferable savings deposits, term deposits (funds left on deposit for a fixed period of time), or repurchase agreements (in which one party sells a security and agrees to buy it back at a fixed price).
  - Securities other than shares of stock, such as tradable certificates of deposit and commercial paper (which is essentially a corporate IOU).

### Inflation, confidence, and dollarization
- Relationship between money supply and prices:
  - If money supply tightens (e.g., not enough gold to mint new money), prices can fall—deflation.
  - If money supply increases while demand for goods stays the same, the value of money drops—inflation.
- Confidence in money is essential:
  - High inflation can erode confidence, leading people to adopt a more stable currency (de facto dollarization).
  - Dollarization implies the government loses its monopoly on issuing money and can be very difficult to reverse.
- Historical policy actions to restore confidence:
  - Turkey rebased the currency, eliminating six zeros in 2005. Overnight, 1,000,000 liras became 1 lira.
  - Brazil introduced a new currency in 1994, the real.
  - These cases illustrate that if everyone accepts a new denomination or currency, it functions as money.

### Key takeaways and policy implications
- Money’s effectiveness depends on three interrelated functions: store of value, unit of account, and medium of exchange.
- The form of money has evolved from barterable goods to precious metals to fiat money; each stage changed how supply and demand for money affect prices.
- Managing money supply requires institutions and credibility:
  - Independent central banks are used to mitigate political temptation to over-issue money.
  - Maintaining public belief in currency is crucial; loss of confidence can produce dollarization or hyperinflation.
- Measuring money through broad money captures various liquid and store-of-value instruments, following the definitions in IMF (2000).

*F&D Magazine: "Money: At the Center of Transactions" — Ceyda Oner and Irena Asmundson*

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_Source: https://www.imf.org/en/publications/fandd/issues/series/back-to-basics/money_