Money

Approaches to defining Money

1. The Conventional Approach
– Money is what money does
– Medium of exchange
– Includes:
• Coin and Paper Currency (C)
• Demand Deposits (D)

2. The Chicago Approach

– Pioneered by Milton Friedman
– Includes: C + D + Time Deposits
 Approaches to defining Money
3. The Gurley-Shaw Approach
– By John Gurley and Edward Shaw
– Both Chicago and Gurley Shaw approaches include
in money the means of payment and those assets
which are close substitutes for the means of
payment. 
– Includes in the list of close substitutes for the means
of payment the deposits of and the claims against all
types of financial intermediaries like saving-bank
deposit, saving and loan association shares etc.
 Approaches to defining Money
4. The Central Bank Approach
– Broadest definition of Money
– Accredited to the Radcliff Committee of the US
– Money is the total credit flow to the borrowers
– Money is identified with the credit extended by a wide variety of sources.
– Uses 4 measures of Money Supply:
1. Reserve Money (M0): It is also known as High-Powered Money, monetary base, base
money etc.
M0 = Currency in Circulation + Bankers’ Deposits with RBI + Other deposits with RBI
It is the monetary base of economy.
2. Narrow Money (M1):
M1 = Currency with public + Demand deposits with the Banking system (current account,
saving account) + Other deposits with RBI
3. M2 = M1 + Savings deposits of post office savings banks
4. Broad Money (M3)
M3 = M1 + Time deposits with the banking system
5. M4 = M3 + All deposits with post office savings banks
 Uses of Money
• Money, as defined by dictionary.com, is:
– any circulating medium of exchange, including coins, paper
money, and demand deposits.

• However, for the purposes of economics, money actually has

four distinct uses:

• These uses are:

– a Medium of Exchange
– a Unit of Account
– a Store of Value
– A standard of deferred payment
…a Medium of Exchange

• By definition, a Medium of
Exchange is anything that is used
to determine value during the
exchange of goods and services.
• Money allows us to use systems of
trade beyond the Barter System.
– Bartering is directly trading
one good or service for
another.
• Money acts as a common ground
for determining value.
…a Unit of Account

• Money can be used as a means

to compare the values of goods
and services.
• One can use the monetary
value assigned to a specific
good or service and compare it
to one offered by a different
provider.
• Money allows us to compare
similar offers for goods and
services to determine the best
value.
…a Store of Value

• Money is used to maintain the

value of a transaction over
time.

• If you receive monetary

compensation for a good or
service, the actual amount that
you received does not change if
you do not use it immediately.

• However, the functional value

of the stored money may
change over time due to other
factors.
 Standard of Deferred Payment

 Make possible contracts for goods and

services against the bond and securities
 What then is Money?

• An item must have six key characteristics to be

considered as “Money”.
• These Characteristics are:
– Durability
– Portability
– Divisibility
– Uniformity
– Limited Supply
– Acceptability
• Durability means that the item must be able to withstand
being used repeatedly such as currency, coins and paper
bills used as money meet this requirement.

• Portability means that individuals are able to carry money

with them and transfer it easily to other individuals.

• Divisibility means that the money can easily be divided into

smaller units of value, different coins and notes denotes
different fractional values.
• Uniformity means that all versions of the same
denomination of currency must have the purchasing
power. As an example, a 1930 Rs 10 note will still buy
Rs 10 worth of goods or services today.

• Limited Supply means that restrictions on the

amount of money in circulation ensure that values
remain relatively constant for the currency. The
responsibility for maintaining an adequate money
supply falls on the Central banking System.

• Acceptability means that everyone must be able to

use the money for transactions.
Evolution of money:

 Barter system

 Commodity money

 Paper money

 Demand deposits

 E-money
 Barter system:
Direct exchange of goods and services for other goods
and services

Difficulties in barter system

 Lack of common measures of values.

 Difficulties in storing values.
 Absence of Deferred payments / loaning.
 Indivisibility of certain goods.
 Commodity money:

• Commodity money is money whose value is

derived from a commodity from which it is
made. Commodity money consists of objects
that have value in themselves as well as value
in their use as money.
 Paper money:

• Paper currency that is circulated for

transaction-related purposes. The printing of
paper money is typically regulated by a
country's central bank/treasury in order to
keep the flow of money in line with monetary
policy.
 Demand deposits:

• Demand Deposit refers to a type of account

held at banks and financial institutions that
may be withdrawn at any time by the
customer. The majority of such Demand
Deposit accounts are savings and current
accounts.
 E-money:
• All types of money people deal with
electronically, far from traditional ways of
payment like cheques, paper money and coins,
e-Money allow users through internet or
wireless devices to pay the charges of their
purchases directly from their bank accounts
by electronic means such as Smart cards,
Digital wallets and micropayments portals.