What is money?
Table of Contents:
What is money? Money is anything that complies with the following criteria:
• Medium of exchange.
• Store of value.
• Unit of account.
• Standard of deferred payment.
The best example of the total erosion of these criteria in a currency is the currency of the country referred to earlier (with the highest inflation rate ever recorded). In 2009 the stage was reached when the particular currency was no longer accepted as a medium of exchange, a store of value, a unit of account or a standard of deferred payment. The mediums of exchange in this country became the USD and the ZAR. Inflation fell to low numbers almost instantaneously
It will be evident that of the four criteria, medium of exchange is paramount, and the other criteria are subordinated to this one. Consequently, we can think of money being anything that is accepted as a means of payments / medium of exchange.
So what is the medium of exchange? It made up of two parts:
• Bank notes (usually issued by the central bank) and coins (usually issued by the central bank and in some cases by government) (N&C).
• Bank deposits (BD).
Bank notes and coins are well known as a medium of exchange; we use them every day to make purchases and to repay debts. However, bank deposits acting as a medium of exchange is often a little confusing. Consider how many payments are made by bank cheques (diminishing fast) and electronic funds transfers (EFTs). When an EFT payment is made (best example = internet banking) the payer's deposit account at the bank is debited (made less by the amount) and the payee's deposit account at the bank is credited (added to). Similarly, a payment by cheque results in the cheque writer's deposit account being debited and the cheque receiver's account being credited: (when posits the cheque of course).
Figure 1: what is money?
Money is not the EFT or the cheque. They are merely instruments that lead to the shifting of a deposit amount from one bank account to another. The deposit is money, as is N&C. Thus the total stock of money (M3 - see below) at a point in time is the total amount of N&C and BD in the possession of individuals and companies:
The individuals and companies can be called the "non-bank private sector" (NBPS). This of course excludes money in the possession of banks (= N&C), the foreign sector and government deposits. Figure 1 endeavors to provide an image of "what is money?"
Measures of money
We know that N&C can be used immediately for payments. We also know that current / cheque account (and some other) deposits can be used as such. We also know that other deposits can be used as money after a short notice period, and so on.
The central banks of the world have developed many definitions of money, ranging from M0 to M4. In the interests of pedagogy (overlook detail and stick with principles) we will use the definition of money M3. This includes N&C all BD of the NBPS. We will not be far off the mark in terms of liquidity because for the most part NBPS bank deposits are short-term.
It is notable that in most developed countries NBPS BD makes up 96-98% of M3 (and N&C the balance of course). In some developing countries this number can be quite low, indicating a low confidence level in respect of banks.
Monetary banking institutions
Most countries have some or all of the following deposit intermediaries:
• Private sector banks.
• Central bank.
• Land Bank.
• Rural banks.
• Mutual banks.
• Building societies.
• Post Office Bank.
These intermediaries are usually also referred to as the monetary banking institutions (MBIs) and they are the intermediaries that make up the monetary banking sector (MBS). These intermediaries play a substantial role in the financial system as follows:
• As the custodians of the major part of the money stock of the country (i.e. NBPS deposits).
• As issuers of N&C (in some countries certain private banks issue bank notes).
• As the keepers of government's surplus balances.
• In providing loans to the public sector (usually lower tiers of government).
• In purchasing the debt securities of the central government (= loans which are marketable).
• In providing loans to the household and corporate sectors.
• In the creation of money.
Each central bank on a monthly basis consolidates the statements of liabilities and assets (i.e. the balance sheets) of these intermediaries (in the process netting out interbank claims) in order to arrive at the monetary aggregate number/s and their balance sheet counterparts (BSCs). As we have seen, there are various definitions of money, but the one usually given much attention is:
M3 = N&C (outside the banking sector) + BD (of NBPS with MBIs).
In this text we will refer to the balance sheets of the banks collectively (representing all non-central bank banks) and the central bank.