1.2. Definition of Money

The process of money creation raises a fundamental issue: What is money? In an economy with money but without promissory notes and fractional reserve banking, money is relatively easy to define: Money is the total amount of gold and silver coins in circulation, or their equivalent. The money creation process above, however, indicates that a broader definition of money might encompass all the notes and coins in circulation plus all bank deposits.

More generally, we might define money as any medium that can be used to purchase goods and services. Notes and coins can be used to fulfill this purpose, and yet such currency is not the only means of purchasing goods and services. Personal cheques can be written based on a bank chequing account, while debit cards can be used for the same purpose. But what about time deposits or savings accounts? Nowadays transfers can be made relatively easily from a

savings account to a current account; therefore, these savings accounts might also be considered as part of the stock of money. Credit cards are also used to pay for goods and services; however, there is an important difference between credit card payments and those made by cheques and debit cards. Unlike a cheque or debit card payment, a credit card payment involves a deferred payment. Basically, the greater the complexity of any financial system, the harder it is to define money.

Because financial systems, practice, and institutions vary from economy to economy, so do definitions of money; thus, it is difficult to make international comparisons. Still, most central banks produce both a narrow and broad measure of money, plus some intermediate ones too.

The most generic definition of money is that it is any generally accepted medium of exchange. A medium of exchange is any asset that can be used to purchase goods and services or to repay debts. Money can thus eliminate the debilitating double coincidence of the “wants” problem that exists in a barter economy.

However, for money to act as this liberating medium of exchange, it must possess certain qualities. It must:

♤ be readily acceptable

♤ have a known value

♤ be easily divisible

♤ have a high value relative to its weight; and

♤ be difficult to counterfeit.