M3: Money Theories and Types of Credit (1)

• The most important function of money is that it acts as a specialized means of payment.

  
  

  Final payment is made whenever a seller of a good, or service, or another asset, receives something of equal value from the purchaser, which leaves the seller with no further claim on the buyer.

  Money is the asset which specializes in this role, being generally used to settle transactions.

  
  

  As such it must, by definition, be a store of value, and, in general, it proves efficient to treat the means of payment as the unit of account (Elgar, 2003).
• FUNCTIONS OF MONEY

  Money is anything that is regularly used in economic transactions and serves as a medium of exchange, a unit

  of account and a store value. There are four (4) main functions of money, namely:

  1. Medium of exchange – The most important job of money is to serve as a medium of exchange when any good or service is purchased, people use money. It makes transactions easier because it is universally accepted and then provides us with a shortcut in doing business.
• FUNCTIONS OF MONEY

  2. Standard value – Money is a common denominator in which the relative value of goods and services can be expressed. For instance, a job that pays Php 30.00 per hour would be nearly impossible to fill compared to a job that offers Php 100.00 per hour.
• FUNCTIONS OF MONEY

  3. Store value - Money is a financial asset that can be used to store wealth (income that you have saved and not consumed). As a store of wealth, money pays no interest, but is perfectly liquid. Money’s usefulness as a store of wealth depends on how it will maintain its value.
• FUNCTIONS OF MONEY

  4. Standard of Deferred Payment - Many contracts promise to pay fixed sums of money well into the future. For instance, A couple of examples are 30-year corporate bonds and a 20-year mortgage.
• DEMAND FOR MONEY

  This refers to the quantity of money that individuals wish to hold. Individuals have three motives for holding money.

  ● Transactionary motives - Individuals are paid periodically (weekly, bi weekly, monthly). However food has to be bought, utilities have to be paid, and even bus fares. These regular payments are made during the course of the month but not at the same time that they are paid.

  ● Precautionary motives - Unforeseen circumstances happen in life. Individuals will put money aside for these moments.
• DEMAND FOR MONEY

  ● Speculative motives - This demand arises because individuals hope to make gain from changes in the price of bonds. A bond is a loan to the government or a firm, with a maturity date in the future. Bonds provide interest. 
• THE INFLUENCE OF INTEREST RATES

  ● Consumption – Many consumer goods are bought on credit, so an increase in interest rates discourages this as the price of borrowing has now gone up. So AD decreases. Equally AD will increase if interest rates fall as saving is discouraged and borrowing is now more attractive.

  ● Investment – Much of the investment is financed through borrowing so the same principle as consumption applies here. LOW INTEREST RATE = HIGHER INVESTMENT FOR BUSINESS.
• THE INFLUENCE OF INTEREST RATES

  ● Net Exports – Interest Rates can influence the value of a currency. This is due to the flow of Hot Money,

  the higher the interest rate the greater the flow the stronger the local currency gets. A strong pound will

  lead to imports being cheaper, so consumers suck in imports, this leads to a trade deficit and low net

  exports. Exports as a result of a strong pound are now more expensive
• INTEREST RATES & UNEMPLOYMENT

  A tightening of monetary policy (raising interest rates) will lead to unemployment due a fall in output. A loosening of monetary policy (lowering interest rates) would increase employment due a rise in output.
• INTEREST RATES & INFLATION

  Interest Rates can be used to help a central bank reach an inflation target. A higher interest rate will mean inflation is lower. A lower interest rate will mean inflation is higher. This can be observed on an Aggregate Demand/Aggregate Supply Curve.
• INTEREST RATES & CURRENT ACCOUNT

  If Interest Rates are high then it lowers AD which discourages the purchase of Imports which means the trade balance would look favourable. Lower interest rates would lead to a rise in AD so consumers suck in imports, which makes the trade balance worse.
• GENERALIZATION:

  Money is generally described as having three functions. The first function is sometimes described as a medium of exchange and at other times as means of payment. The term medium of exchange clearly suggests that the role of money is to facilitate exchange, and the existence of money is seen to overcome the problem of the double coincidence of wants. The term means of payment indicates that money is used to settle payments and debts. We used the term means of payment since the defining characteristics of money is that it is the generally accepted means of payment.