1.

3 Introduction to Money and

Interest Rates
ROLE OF MONEY IN THE ECONOMY
Money is any item or commodity that is generally accepted as a means of payment for
goods and services or for repayment of debt, and that serves as an asset to its holder.
On the simplest level, money is composed of the bulls and coins which have been
printed or minted by the National Government (these are called currency). But money
also includes the funds stored as electronic entries in one’s checking account and
savings account.
Because money in a modern economy is not directly backed by intrinsic value (e.g., the
coin’s weight in gold or silver), the financial system works on an entirely fiduciary basis,
relying on the public’s confidence in the established forms of monetary exchange.
Money is the oil that keeps the machinery of our world turning. By giving goods and
services an easily measured value, money facilitates the billions of transactions that
take place every day. Without it, the industry and trade that form the basis of modern
economies would grind to a halt and the flow of wealth around the world would cease.
Money has fulfilled this vital role for thousands of years. Before its invention, people
bartered, swapping goods they produced themselves for things they needed from
others. Barter is sufficient for simple transactions, but not when the things traded are of
differing values, or not available at the same time. Money, by contrast has a recognized
uniform value and is widely accepted. At heart a simple concept, over many thousands
of years, it has become very complex indeed.
At the start of the modern age, individuals and governments began to establish banks,
and other financial institutions were formed. Eventually, ordinary people could deposit
their money in a bank account and earn interest, borrow money and buy property, invest
their wages in business, or start companies themselves. Banks could also insure
against the sorts of calamities that might devastate families or traders, encouraging risk
in the pursuit of profit.
Today it is the nation’s government and central bank that control a country’s economy.
The Federal Reserve (known as “The Fed”) is the central bank in the US. The Fed
issues currency, determines how much of it is in circulation, and decides how much
interest it will charge banks to borrow its money.
In the Philippines the central bank that controls the country’s economy is the “Bangko
Sentral ng Pilipinas”. While government still print and guarantee money, in today’s world
it no longer needs to exist as physical coins or notes, but can be found solely in digital
form.
 
CHARACTERISTICS AND KEY FUNCTIONS OF MONEY
Money is not money unless it has all of the following defining characteristics: Money
must have value, be durable, portable, uniform, divisible, in limited supply, and be
usable as means of exchange. Underlying all of these characteristics is trust – people
must be confident that if they accept money, they can use it to pay for goods.
              Store of value
              Money acts as a means by which people can store their wealth for future use. It
must not, therefore, be perishable, and it helps if it is of a practical size that can be
stored and transported easily.
              Item of worth
              Most money originally has an intrinsic value, such as that of the precious metal
that was used to make the coin. This in itself acted as some guarantee the coin would
be accepted.
              Means of exchange
              It must be possible to exchange money freely and widely for goods, and its
value should be as stable as possible. It helps if that value is easily divisible and if there
are sufficient denominations so change can be given.
              Unit of account
              Money can be used to record wealth possessed, traded or spent-personally
and nationally. It helps if only one recognized authority issues money. If anybody could
issue it, then trust in its value would disappear.
              Standard of Deferred Payment
              Money is also useful because of its ability to serve as a standard of deferred
payment.
 
Money can facilitate exchange at a given point by providing a medium of exchange and
unit of account.