This article seeks to discuss in brief what may be deemed an easy question to answer- What work does money do? The answer to this question is simple, and in most instances, even a kindergarten kid can be able to narrate the works of money. During my primary school days, I would make sure that before I leave for school, I get my pockets filled with a few cents to be able to buy sweets, snacks, and biscuits during break time. As some years passed by with the help of education, I began to understand that money has few more uses than I thought. It facilitates trade by making it easier to buy and sell goods compared to barter, the exchange of nonmoney good for another which was the common practice back then. (If you’ve ever traded, clothes, maize, phone numbers, homework assignments, or any other nonmoney goods, you’ve in one way or the other engaged in barter.
Good money is characterized by stability, scarcity, portability, divisibility, uniformity, acceptability, and durability. Money can be identified as anything that is generally acceptable in the settlement of debts. It can be described by what it does, that is, money can best be described by its functions. In Money and the Mechanism of Exchange (1875), William Stanley Jevons famously analyzed money in terms of four functions: a medium of exchange, a common measure of value (or unit of account), a standard of value (or standard of deferred payment), and a store of value. Money plays the following important roles in the economy.
Money as a medium of exchange allows consumers to exchange their preferences. That is people exchange their goods and services for money rather than for other goods and services like what used to happen in barter trade. When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange. It thereby avoids the inefficiencies of a barter system, such as the inability to permanently ensure "coincidence of wants. Thus, money is usable in buying goods and services.
Money as a measure of value becomes a common denominator upon which relative exchange values can be established, that is to say, a unit of account is a standard numerical monetary unit of measurement of the market value of goods, services, and other transactions. The value of one product can be expressed in monetary terms (price). For example, the value of a car can be expressed as $200m and not 20 herds of cattle.
Money presents a convenient form in which to store wealth especially because of its liquidity, that is, money can easily be used to pay for transactions. People can prefer to keep their wealth in the form of money which is liquid rather than illiquid assets such as bonds. One other reason for this preference is because money is not perishable as compared to some other assets such as cattle. To act as a store of value, however, money must be able to be reliably saved, stored, and retrieved – and be predictably usable as a medium of exchange when it is retrieved. The value of the money must also remain stable over time. Some have argued that inflation, by reducing the value of money, diminishes the ability of money to function as a store of value.
Deferred payments are future payments obligations. Money as a standard of deferred payments allows credit transactions to be undertaken. For example, people can buy on hire purchases and sign a contract to repay in monthly installments. Money should maintain a constant purchasing power over a long period if it were to perform these functions properly. When debts are denominated in money, the real value of debts may change due to inflation and deflation, and for international debts via devaluation.
The different functions of money give rise to different definitions of money supply in the economy. The official definition of money supply in Zimbabwe is M3 which is derived as follows:
M1 defines transaction money, that is, money used to pay for day-to-day transactions, and it is given by;
M1 = Notes and coins in circulation + Demand deposits with financial institutions. Demand deposits refer to deposits that can be withdrawn without giving notice of withdrawal to the bank, for example, current account deposits.
This definition identifies all deposits that are easily convertible into cash. These deposits are made up of notes and coins in circulation, demand deposits with financial institutions, savings deposits, and fixed time deposits that mature within 30 days.
Thus M2 is given by;
M2 = M1 + Savings deposits + Fixed time deposits that mature within 30 days.
This definition includes quasi or near money, that is, assets that are not easily convertible into cash. This is the official definition of money supply in Zimbabwe, and it is given by;
M3 = M2 + Fixed time deposits that mature after 30 days. Thus, M3 has five items, namely notes and coins in circulation, demand deposits with financial institutions, savings deposits, fixed time deposits that mature within 30 days, and fixed time deposits that mature after 30 days.
Keynes described the demand for money as "demand for money to hold." This is the amount of cash balances people wish to hold rather than illiquid assets that yield income such as bonds or government securities. The demand for money is called liquidity preference. Keynes identified three motives for holding money:
(i) Transaction’s motive
People hold money to use to buy goods and services, that is, they need money to pay for day-to-day transactions such as bus fare.
(ii) Precautionary motive
In addition to the amount of money they hold to pay for day-to-day transactions, additional cash is held for precautionary purposes, that is, to make it available in case of need, not only for an emergency such as illness but even to buy a bargain if it should be available.
(iii) Speculative motive
People also hold cash balances to take advantage of improving interest rates and prices of financial assets. John Maynard Keynes, in laying out speculative reasons for holding money, stressed the choice between money and bonds. If agents expect the future nominal interest rate (the return on bonds) to be lower than the current rate they will then reduce their holdings of money and increase their holdings of bonds. If the future interest rate falls, then the price of bonds will increase, and the agents will have realized a capital gain on the bonds they purchased. This means that the demand for money in any period will depend on both the current nominal interest rate and the expected future interest rate (in addition to the standard transaction motives which depend on income).
Author: Tillas Gopoza is an Economist. He writes in his capacity as the Chief Economist for the Bankers Association of Zimbabwe. He can be contacted at tillas@baz.org.zw