In modern economies, like that in the United States, money comes in the form of paper currency, metal coins, and balances in checking accounts. However, throughout history a wide range or items have been used as money, including rocks, livestock, gemstones, animal skins, and even chocolate bars. Items that best serve as money have the characteristics of durability, divisibility, transportability, and noncounterfeitability.

Value

• Value in use results when a good or service provides satisfaction of wants and needs. This is sometimes termed intrinsic value. Hot fudge sundaes, polio vaccines, and televised sporting events provide value is use. A person who consumes these goods and services is better off or more satisfied.


• Value in exchange results when an item can be traded for a good or service with value in use, but that item need not have intrinsic value in use. Money has value in exchange. An item need not have value in use to effectively function as money and as a medium of exchange, so long as it has value in exchange.

Functions

A word or two about each seems in order:

• Medium of Exchange: This function means that money is accepted throughout the economy as payment for goods and services. Buyers acquire goods by giving up money. Sellers receive money when parting with their goods. This is, without question, the most important function of money. This is the function that makes money MONEY.


• Unit of Account: This function means that money is used to designate the prices of goods and services. Any item that is generally accepted as payment for goods and services is also the obvious choice for denominating the prices of those goods and services.


• Store of Value: This function means that money can be used to purchase the same quantity of goods and services, that provide the same consumption value, in the future as it can purchase today. Inflation is the primary nemesis for the ability of money to store value.


• Standard of Deferred Payment: This function means that money is used to designate future payments, such as those for loan repayments. The standard of deferred payment is a natural result of the standard unit of account and store of value functions of money.

Characteristics

• Durability: Items that work best as money tend to durable. Durability allows a money item to store value, and especially to retain value in exchange transaction after transaction. Durability is one big reason that metals, such as gold and silver, rose to the ranks of money.


• Divisibility: The more easily an item can be divided into small increments, the better it can perform the medium of exchange function. To be generally accepted in payment, money needs to be exchangeable for both battleships and bubble gum.


• Transportability: Because market transactions take place at different locations, items that function best as money must be easily moved from market to market. If it takes more time, effort, and resources to MOVE money to the market than what they money can buy, then the money is not very useful.


• Noncounterfeitability: Items that function best as money are those that are difficult to duplicate or counterfeit. Money that is easily counterfeited quickly loses its value in exchange because ANYONE can create their own money. And if you can create your own money, you have no reason to accept in trade for the valuable goods and services in your possession.

U.S. Money

While checking accounts are technically under the jurisdiction of banks, they are indirectly controlled through the actions of the Federal Reserve System. The total of currency, checking account balances, and a few other minor items (like traveller's checks) constitute what Fed officially labels M1. The Fed also has an M2 and other M-numbers that include other types of bank accounts and financial assets.

Policies

The two basic forms of monetary policy are expansionary and contractionary:

• Expansionary monetary policy: This consists of an increase in the quantity of money circulating around the economy, usually combined with an decrease in interest rates. The purpose of expansionary monetary policy is to stimulate the economy during times of a business-cycle contraction and resulting high rates of unemployment.


• Contractionary monetary policy: The alternative is a decrease in the quantity of money in circulation, combined with a increase in interest rates. The reason for contractionary monetary policy is to put the brakes on the economy during times of a business-cycle expansion when inflation is on the rise.