21) money Flashcards
what is fiat money?
Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. In other words, a UK £10 note is not physically worth £10- the value of the actual printed bit of paper might be 1p or less.
However, the government decrees that a £10 note entitles you to goods and services valued at £10.
what is legal tender?
Legal tender means that a seller is obliged to accept that in payment for the good or service they are selling. On the other hand, a 10 Euro note is not legal tender in the UK, sellers are not obliged to accept Euros. Obviously, the historic concept of legal tender is now evolving due to the emergence of a “cashless” society; in reality the payee may choose to refuse or accept any specific type of payment, whether legal tender or not.
what are money’s main functions:
- Medium of exchange- it enables us to easily purchase goods and services
• Store of value- it can be stored, invested kept safe for future use
• Measure of value (Unit of account)- can be used to value goods and services, record debts, make calculations.
• Standard of deferred payment- some sources use this as a 4th function of money- i.e the existence of money allows us to receive and award credit as well as borrowing and lending facilities
when does money loose its function?
High inflation, especially hyperinflation, erodes all of these functions.
which characteristics should money possess?
- Durability- money must nor rot, or either away. It has to physically last a decent period of time. If it didn’t it would not be useful as a store of value and not always acceptable as a medium exchange
- Portability- money must be easy to carry and move around, essential for it to be a good medium of exchange.
- Divisibility- it should be possible to divide units of money down into smaller portions. Otherwise it would not be possible to exchange money for smaller items
- Uniformity- each £10 notes, each £1 coin, should be the same as the next. Otherwise its functions as a medium of exchange and measure of value are completely undermined
- Relatively scarce- money needs to be limited in supply. If it wasn’t then it would not hold its value and none of the above functions would be met
- Acceptable to all- Money must be widely accepted as a payment for debts or for purchasing goods and services- this is what gives money its value. Cryptocurrency has not overcome this hurdle as yet.
where does money come from?
In the UK, coins are made by the Royal Mint, bank notes printed by the Bank of England. However, notes and coins are only a tiny% of actual money in the UK- most money is made up by the banks.
Banks are able to do this due to the rule that they only ever need to hold about 3% of their deposits in cash.
how do banks make the money? what then happens?
if person X deposits €100 in a bank that enables the ban to lend £97 that did not previously exist. This £97 has increased the money supply in the economy and thereby facilitated more economic activity. It should be obvious from this that increasing the money supply is intrinsically related to higher AD and economic growth. Of course, this only works if there is spare capacity in the economy- if we’re at fe and no new goods or services can be made then the new money is just going to inflate prices. Inflation therefore is often defined as too much money chasing too few goods.
why are money and banks important?
All economies rely on money to function. The supply of money in an economy is central to the value and acceptability of money- if too much money is supplied (e.g. if the banks lend out too much) inflation occurs and all of the functions of money gets undermined. A key role of the Bank of England is to manage the supply of money in the UK.
