Last Updated on: 9th October 2024, 08:01 am

Economics of Money

Money

In this part, we discus about Money and related topics like:

• Types of Money
• Functions of Money
• Money Stock Classification

Money

In general term, Money is a sort of commodity which passes freely from one hand to another as medium of exchange and accepted in payment of goods or in discharge of debts and business obligations.

In legal terms, ‘Anything which is declared by the state as money, is money’. Thus, only legal tender money which nobody can refuse to accept is money. Anything which is not declared by the state as money, such as credit money, cannot be included under the definition, though it may have the economic effects as legal tender money.

Money is most liquid asset as it is readily convertible into other assets.

Classification of Money

• Legal Tender Money. Legal Tender Money means money, the tender or payment of which constitutes discharge of a debt. Some types of money are legal tender for any amount. They are termed unlimited legal tender, e.g., the Rupee in Indian and the Pound note in U.K. Some types of money are legal tender up to a fixed amount. They are known as limited legal render. In India the half-rupee is legal tender up to Rs. and small coins are legal tender up to Re.1.

• Bank Money. Bank Money includes bank-notes and deposits in a bank (both current and fixed) overdraft facilities. These items, normally can be freely used for making payments. They are therefore commonly treated as money. Strictly speaking, Bank Money is an acknowledge­ment of a debt, while money proper or Current account is money issued by the State and is legal tender.

• Money Substitutes. Cheques, Bills of Exchange, Postal Orders, Treasury Bill and Bearer Bonds are used for making payments among known parties. They are not regarded properly as “money” but regarded only as “money substitutes”.

• Money of Account. Money of Account is the unit in which accounts are kept and by which values are recorded. The money of account is usually the same as the legal tender money. The Rupee in India and the Dollar in U.S.A. are both legal tender money and the money of account.

• Token Money. Token money means money whose market value or face value is more than the value of its contents. People accept such money at a higher value because of its benefits of legal tender quality. The small coins of India, e.g., 50 P, 20 P etc., are token coins.’

• Commodity Money. Commodity Money implies money made of some metal. When the face value of such money is equal to the value of the metal contained in it, it is also called a full-bodied and full-weight coin.

• Credit Money. It is also known as bank money. This consists of deposits held with bank which are payable on demand by the depositors. Cheque, drafts, bill of exchange etc. are example of credit money.

• Cash. The term Cash is ‘used with a variety of meanings, viz., (i)’ coins and notes together, (ii) coins only, and (iii) small change. In bank accounts, the terms cash is used to mean currency in the till plus deposits in the central bank.

• Coin. A coin is a piece of metal of definite design issued by the Government with a mark showing its legal tender value. A coin has two values (i) an intrinsic value (as a piece of metal) which depends on the market value of the metal, and (ii) a legal tender value or face value which is fixed by the Government.

• Currency. The term Currency is used to include both coins and notes. In the foreign exchange market, however, the term is used to mean particular currency units (e.g.  the £ or $).

• Paper Money. Paper Money implies money made of paper. All countries use “paper money nowadays. There are three types of paper money :

• Representative or Convertible. When the paper money merely represents a certain quantity of metal or coin and is conver­tible into them at the pleasure of the holder, it is termed Representative or Convertible.
•  Fiduciary. When the paper money contains a promise to pay the holder a certain quantity of legal tender money, it is called Fiduciary (like a 100 rupee note).
•  Inconvertible or Fiat. Currency that a government has declared to be legal tender, but is not backed by a physical commodity. Such notes are supposed to circulate because of the authority (or fiat) of the state.

Functions of Money

• Medium of Exchange: Money came into use to remove the inconveniences of barter. People exchange goods and services through the medium of money. Money by itself has no utility. It is only an intermediary. Money is used as a medium of exchange or means of payment. All kinds of transactions of goods and services are conducted using money. Transactions of various goods can be conducted independently i.e. purchase of another goods does not require simultaneous sale of another.
• Measure of Value: Money is the measuring scale, by which the values of other commodities and services are expressed. Even when money is not used as a medium of exchange (e.g. in international barter transactions), it may be used for expressing the relative value of the commodities exchanged, and for accounting purposes. Money acts as unit of account, to measure the value of all kinds of goods and services.
• Standard of Deferred Payments: Debts are usually expressed in terms of money of account. Loans are taken and repaid in terms of money.

Theuse of money as the standard of deferred or delayed payments immensely simplifies borrowing and lending operations and thereby facilitates the formation of capital markets and the work of financial intermediaries like Stock Exchanges, Investment Trusts and Banks.

• Store of Value: Money, being generally acceptable, is the best form of reserve. Wealth can be stored in the form of other assets as well, but money is the best form of holding assets, as money is the most liquid of all assets.

Drawbacks of Money.

• The value of money is not stable. Monetary instability causes maldistribution of income and wealth.
• Frequent changes of the value of money producing inflation, devaluation etc., may harm trade.

Money stock classifications

Classification of Money by Reserve Bank of India :

i).Old classification

a.Narrow Money           M1        = Currency with the public + Demand deposits of the public
M2        = M1 + Post office saving deposits.

b.Broad Money             M3        = M1 + Time deposits of the public with banks
M4        = M3 + Total post office deposits.

ii)New classification     M1        = Currency + Demand deposits + Other deposits with RBI
M2        = M1 + Time liabilities portion of saving deposits with banks + certificates of deposits issued by banks + term deposits maturing within a year (excluding FCNR Deposits).
M3        = M2 + Term deposits with banks with maturity over one year + Call/term borrowings of the banking system.
M4 has been excluded from the scheme of monetary aggregates.

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