The term “money” is derived from the Old High German word “gelt”, which is translated with payment and remuneration.
Money in particular:
- Euro – the European common currency
- fixed deposit
- lend money
- Money from private
- call money
In today’s language, money means the socially accepted and legally introduced means of payment.
As such, it replaces the former natural exchange, which provided for an exchange of commodity for commodity. Since the introduction of money, the economic cycle has been characterized by a combination of flows of goods and money.
The three functions of money
Economics assigns three different functions to the means of payment. First and foremost, it fulfills the function of a medium of exchange, which facilitates the exchange of goods of all kinds.
The exchange of money for goods or services is an important part of the economic cycle. In its function as a legally recognized means of payment, it can be used to settle liabilities with a debt-discharging effect and to take out loans. In these cases, it is not about goods, but financial transactions.
Second, money serves as an abstract unit of calculation, with which all goods can be expressed in prices. As a result, goods and services are relatively easy to compare in terms of their value. In contrast to the original natural exchange, there is no need to evaluate the respective exchange ratio of all individual goods among each other. In this sense, money represents a standard of value.
In its third function, money fulfills the role of a store of value. The acquisition of funds and the use of money do not necessarily have to take place at the same time. Money offers the possibility to keep it for a certain period of time in order to exchange it later for goods or services. The prerequisite for this, however, is that its value stability is given. This value retention function is used in the context of saving. When saving money is kept for a certain period of time or indefinitely. For the time being, the saver waives the right to use it in business transactions for the purchase of goods or for the settlement of debts. As compensation for his resignation, he receives interest when depositing his money on savings accounts.
In fulfilling its functions, money can appear in different forms. It is differentiated between cash and book money. Cash includes coins and banknotes. It is characterized by the fact that the service provided can be paid directly with this form of cash (cash payment). The money is thus transferred by the payer directly to the payee.
By comparison, book money (bankroll) refers to cashless payment transactions. It appears in the books of the banks and, unlike cash, is not considered a legal tender. However, since it can be converted into cash at any time, it is increasingly being used as a means of payment in business. Conversely, cash can also be converted into book money by paying it into an account. Book money can be transferred among other things by transfers, direct debits, credit card payments and on-line transfers.
Money and quantity
The central bank controls the amount of money in circulation (money supply). It has the right to print and circulate banknotes. By purchasing assets, they can increase the money supply by paying with banknotes and thus bringing additional money into circulation. This process is called money creation. Similarly, when the central bank extends or reduces commercial banks’ lending volume, the money supply is affected.
This two-tier banking system, consisting of central banks on the one hand, and commercial banks on the other, distinguishes between different types of money. Based on the Eurosystem, the speed of
Availability differentiated between the M1, M2 and M3. Cash includes banknotes issued by the central bank and coins minted by government agencies. Together with the daily deposits of commercial banks (sight deposits) cash forms the money stock M1. The money supply M1 is combined with the time deposits and savings deposits for the money stock M2. The money stock M2 is in turn extended by the near-cash securities to the money stock M3.
The monetary base of an economy is the sum of the cash in circulation and the sight deposits of the commercial banks with the central bank.
Demand for money
While monetary supply can be influenced by the central bank, money demand is geared to the economy and consumer behavior of households. The demand for money is determined by the extent to which there is a desire to keep money. In particular, money is held if there is an intention to buy goods or use services.
The extent of money demand is based on how much money is expected to be needed to make the desired purchases. It also matters how high the return on alternative forms of investment such as securities.
Money and financial markets
In a money-oriented economy, there are monetary and financial flows on the one hand and flows of goods on the other. As a result, in addition to the goods market, monetary and financial markets exist. These individual markets are not independent of each other, but mutually influence each other. Negative and positive developments in the financial and money markets can therefore affect the economic cycle. This interlocking became clear in the recent economic crisis, which began with erroneous developments on the financial markets and finally led to a general economic crisis.
The money market is part of the financial market, which in turn includes all markets on which capital is traded. There are both national and international financial markets. With regard to the type of financial assets traded, the financial market is divided into money market, capital and credit market and foreign exchange market.
The money market covers short-term investments (maturity up to one year or up to a maximum of two years). In a narrower sense, it is limited to central bank money trading between the central bank and commercial banks and commercial banks. This money market in the narrow sense is the subject of monetary policy, with which the central bank can control the money supply and the money market interest rate. In a broader sense, the money market involves the internal trading of book money from commercial banks, which in this way invest their short-term liquidity surpluses or fill their liquidity shortages. The basis for this is the money market rate, which determines the supply of money and money demand.
Due to the interrelations between the two parts of the money market, a change in the money market interest rate (interest rate for central bank money) has an effect on the interest rate on book money in the commercial banking sector. By setting the interest rate on the money market, the central bank can influence the general market interest rate across markets. In the credit market, businesses and consumers can cover their need for money with loan financing provided by the commercial banks.
The loan interest rate charged on loans is based on market interest rates, which in turn are based indirectly on the money market interest rate of the central bank. In the eurozone countries, this is the main refinancing rate standardized by the EurCen Bank, to which the Qentral bank lends money to commercial banks.
The value of money
Money can be valued with the face value and the real value. The nominal value corresponds to the nominal value, which is granted to the legal tender money. Thus, a 20-euro banknote has a nominal value of 20 euros. The real value of the money indicates how much you can buy for it. It is measured in unit units and referred to as purchasing power. The purchasing power of money is that amount of goods that can be purchased with a certain amount of money.
The stability of the price level is considered one of the key objectives of monetary policy. It is directly related to the purchasing power of money. The general price level is measured by a price index, using in practice the GDP deflator and the consumer price index (CPI). While the GDP deflator measures the price evolution of all final products produced, the CPI uses a compiled basket of goods to record the average price development of goods and services purchased specifically by consumers.
Inflation and money
If the general price level continues to rise, then there is inflation. As a result of inflation, the real purchasing power of money decreases. This in turn means that less money can be purchased for a monetary unit. There is a devaluation of the money. The inflation rate (price increase rate) gives information about the extent of the price increase. Regarding the causes of inflation, various theories are advocated. According to the monetary explanations, an expansion of the money supply, which is too strong in relation to the actual production of goods and services, causes
an inflation. With these approaches, the general rise in price levels results directly from a money market trend. The non-monetary theories, on the other hand, see the causes of inflation in the goods economy and in politics. In the goods sector, a differentiation must be made between demand-induced and supply-induced inflation. If aggregate demand is higher than the aggregate supply, this excess demand causes a rise in commodity prices and demand inflation. The surplus demand may result from a decrease in the savings rate, an increase in investment or a strong increase in export demand.
On the supply side, companies can raise their higher production costs (personnel, energy, interest) on prices (cost pressure inflation). If companies use their market power to drive higher profits, there may be a profit pressure inflation. In both cases, the wage-price spiral that has been set in motion can further increase inflation. One possible cause of inflation can be found in a failed central bank anti-inflation policy (politically induced inflation).
Both on the demand side and on the supply side, inflation can be transferred from abroad to domestic (imported inflation).
When prices of goods and services continue to decline, it is called deflation. This general price decline is reflected in a negative inflation rate. The real purchasing power of money is increasing and the money is upgrading. In times of bad economic activity, private households react hesitantly to consumer spending due to insecurity and fear of worsening their income situation or losing their job (consumption strike). Instead, they are increasingly focusing on saving.
In the same way, companies limit their investments to the essentials and respond to the decline in demand with rationalization measures (eg redundancies). Due to the excess supply prices fall. With prices falling, consumers tend to push their purchases out, expecting further price cuts. Deflation can trigger a downward spiral as economic performance progressively sinks.