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Money and its Functions
Introduction
Money is an integral and essential part of the financial system in each country. The United States dollars, Russian rubles, British pounds or French francs - money serves as the means of payment and the measure of value in all economic systems. In this paper, we try to consider the nature of money, their economic importance and the factors that determine their amount (mass). We will attempt to show how great is the economic importance of the money exchange and the significance of the role that money plays in economic policy development.
Money is something that is taken as payment for goods, services and debts. Money is a medium of exchange; people take money in exchange for goods and services that they provide in the expectation that they can then exchange money for goods and services that they want to purchase. Without such a medium of exchange people should turn to barter - the direct exchange of goods and services for other goods and services. Barter is a very ineffective means of the exchange. For a barter, it is necessary to find a partner who has what you need, and he must want what you are offering to exchange. This requires a search of potential partners for the exchange, capable of satisfying the needs and wishes of each other, and then reach agreement on the terms of the exchange. Thus barter leads to high costs associated with the search and high transaction costs too. In other words, in the natural exchange people have to spend a lot of time searching, negotiating and incur other significant costs in trading activities (Staff, 2004).
Money serves as a unit of account, or "measure of value." The role of money as a "unit of measurement" allows the use of fixed prices for the transactions. Functions of money as a unit of account allow people to measure the economic values in an easy and understandable way. Apart from the fact that money serves as a medium of exchange and unit of account, they still provide a very convenient way to save (store of value) and a convenient way of borrowing money (means of deferred payment). As a "store of value", money facilitates the implementation of the accumulation of current income by guaranteeing the future purchasing power. As a "means of deferred payment", money facilitates borrowing (and lending), providing the measure of purchasing power, which is currently time borrow and lend. Money is unique in its simplicity, as a means of payment for goods and services: they have the highest liquidity among all funds (Jevons, 2016).
The essence of money as an economic category is shown in their functions, which express the inner framework, the content of the money. In this paper, we will consider the five basic functions of money: a measure of value, medium of exchange, a means of payment, store of value, and world money.
The Function of Money as a Measure of Value
Money is the universal equivalent and they measure the value of all goods. However, money does not make the goods commensurate. The goods are commensurate in relation to the socially necessary labor expended on the production of goods, creating the conditions for their adjustment. All products are the products of socially necessary labor, so the real money (gold and silver), which have the value, can serve as a measure of their value. In this case, the money measures the value of the goods perfectly, i.e. in the commodity owner does not need to have cash.
The cost of goods expressed in money is called the price. It is determined by the socially necessary labor costs of its production and sales ("The Science of Political Economy, Part V, Chapter 3", 2016). The basis of the prices and their changes is the law of value. Product price is formed on the market and in case of equality of supply and demand for the goods it depends on the cost of goods and the value of money. The actual cash price of the goods is directly proportional to the cost of these goods and inversely proportional to the value of money. Due to the mismatch of supply and demand on the market, the price of a commodity inevitably deviates from its value. According to such deviations in prices (up and down), producers determine the goods that were not enough produced, and the goods that are in abundance.
In the times of the gold standard, the price depended on the value of the goods, since the cost of money-gold has been relatively constant. In the economic systems with paper money and banknote systems, the prices of goods are expressed in the signs of value. Money does not have its own value, so it may not accurately reflect the value of goods. This implies differences in the prices of the same goods, which complicates the producer’s adoption of correct rational decisions about the production of goods.
The quantitative estimation of the cost of goods in money (the price of goods) enables the comparison of the products of social labor and parts of the same monetary commodity - silver or gold. In order to compare the different prices for the cost of goods, it is necessary to reduce them to the same scale, i.e., express them in the same currency. The scale of price in metallic currency is the weight of the monetary metal, that is accepted in a particular country as the monetary unit and serving for measuring the prices of all other commodities.
There are significant differences between the money as a measure of value and money as the price scale. Money as a measure of value relates to all other goods, it arises spontaneously, varies depending on the amount of social labor expended on the production of the good. Money as the scale of prices is set by the state and acts as a fixed weight of the metal, which varies with the value of the metal. Initially, the weight content of the monetary unit coincided with the price scale, which is reflected in the names of some monetary units. For example, in the past the British pound actually weighed a pound of silver (Rochon & Rossi, n.d.). In the course of historical development, the scale of prices stood apart from the weight content of the monetary unit.
With the establishment of the rule of fiat credit money, the scale of prices has undergone significant changes. The state establishes:
a) the name of the monetary unit, the procedure for issuing and withdrawal, as well as its denominations;
b) the procedure for the release of a smaller currency unit, manufactured, usually from cheap metals, defining its relationship to the basic monetary unit;
c) Rules for the circulation of cash and non-cash;
d) the exchange rate of the national currency against foreign currencies on the basis of its currency demand, publishing it in the official press.
The Function of Money as a Medium of Exchange
In contrast to the first function, where the goods were perfectly estimated in the money prior to their circulation, the money should also be involved in the circulation of goods and services. Commodity circulation includes: the sale of goods (i.e., turning it into the money) and the purchase of goods (the transformation of money into commodities). This process is also called commodity – money - commodity (C - M - C). In this process, money plays the role of mediator in the exchange process. The functioning of money as a medium of circulation creates conditions for producers to overcome the individual, temporal and spatial boundaries that are typical in the direct exchange of one commodity for another (barter). Money is constantly in exchange and continuously serves it. This means that the money contributes to the development of commodity exchange (Suresh, 2010).
The emergence of money as a medium of exchange strengthens the contradictions of the exchange process. In the direct exchange of goods (goods for goods), purchase and sale coincided and there was no gap between them. In contrast, commodity circulation involves two separate acts: the purchase of goods and its sale, separated in time and space. It provides an objective opportunity to exchange collisions and crisis situations.
The peculiarities of money as a medium of exchange include, first of all, the real presence of money in circulation and the transience of their participation in the exchange. In this regard, the function of means of circulation can be carried by the defective money - paper and credit money. Currently, the dominant position is taken by credit money by acting as a purchasing and payment means. Money as a means of purchase were typical of simple commodity production: C – M – C. In capitalism, money serves industrial, commercial and money capital. The money circulation formula takes the following form: M - C - M. In spite of the fact that credit money arose from function of money as the means of payment, now it serves mainly the circulation of capital. Credit money acts as a medium and as a means of payment and, therefore, many economists unite the functions of money as a medium of exchange and as a means of payment into one function.
The Function of Money as a Store of Value
Money as a universal equivalent, provides goods to the money owner. Money becomes a universal embodiment of social wealth. Therefore, people have a tendency to the accumulation and saving of money. For the formation of the treasures, money are extracted from the circulation. This means that the act of sale-purchase is canceled. However, the mere accumulation and saving of money does not bring the additional income to the money owner ("Back to Basics: What Is Money? - Finance & Development, September 2012", 2016).
Unlike the previous two functions, money as the store of value should be able to save the value for at least a certain period of time and it has to be real. With the circulation of metal money, this function has performed the economic role of natural regulator of monetary circulation: the extra money was transformed into treasure, the lack of money was replenished at the expense of the treasure.
With the development of commodity production significance of the store of value function was increased. The production became impossible to carry out without the accumulation of savings. The creation of cash reserves in companies provides smoothing of emerging disorders in a separate economic entity. The national reserves of the help in smoothing the imbalances of the economy.
The Function of Money as Means of Payment
The Function of World Money
Foreign trade relationships, international loans, the provision of services to the foreign partners caused the appearance of the world money. In the context of this function, money serves a universal means of payment, the universal means of purchase and universal materialization of social wealth. World money as an international means protrude from the settlement of international balances: if the payments of the country for a certain period exceed its cash receipts from other countries, money is a means of payment.
World money as international means of purchase are used in violation of the balance of exchange of goods and services between countries; then their payment is made in cash. As a universal embodiment of social wealth, the world money is used in the provision of a loan or grant by one country to another, or in the payment of reparations by the defeated country to the victorious one. In this case, a part of the wealth is moving from one country to another by means of money.
In the times of the gold standard, world money included gold as a means of regulating the balance of payments and credit money (banknotes) of some countries (mainly the US dollar and the British pound sterling). For strengthening the national currency of such countries as the United States and United Kingdom, international exchange agreements and foreign exchange clearing were used as world money on the initiative of these countries.
The foregoing suggests three basic properties of money, revealing their essence:
money is to provide universal direct exchangeability. It is used to purchase any goods;
money expresses the exchange value of goods. Through money, the price of the goods is determined. It gives a quantitative comparison of different commodities;
money is the materialization of the universal labor-time, enclosed in the product.
The Role of the Central Bank in Control the Growth of Money Supply
World experience knows two ways to stabilize the economy:
The first is monetarist approach, based on maintaining a minimum level of inflation and the stabilization of money circulation by controlling the money supply and aggregate effective demand. This approach does not ensure structural adjustment and often leads to a reduction in production volumes, the freezing of the investment activity;
The second is Keynesianian approach, based on stimulating the development of production and business activities to facilitate the implementation of structural reforms and the elimination of distortions in the economy, coupled with the control measures of financial and monetary policy.
The implementation of monetary policy is an important priority in macroeconomics, providing control of inflation and monetary growth prevention, the strengthening of the national currency exchange rate stabilization and the achievement of convertibility of the national currency. It is possible to observe the tools and steps in monetary policy and the ways the central bank influences the volume of production and the level of prices for goods and services. The central bank controls the money supply and credit conditions. The central bank has at its disposal a number of tools to achieve the intermediate targets, such as bank reserves, money supply and interest rate. These operations through appropriate tools can achieve the health outcomes for the economy: low inflation, production output growth and low unemployment.
In regulating the money supply, the central bank should focus on the achievement of milestones. They are economic instruments that regardless of bank instruments or final control tasks are as intermediate mechanisms between instruments and objectives. The task of reducing the rate of inflation provides for mandatory control over the growth of money supply (defined as the sum of cash and bank deposits). In particular, the growth of money supply should be limited to a level sufficient to maintain the desired level of growth of the nominal GDP at the proposed change in the velocity of money circulation (defined as the ratio of nominal GDP to the volume of money supply). Central banks cannot exercise direct control over the growth of money supply. And yet they have the opportunity to indirectly influence its growth, controlling the growth of the monetary base. The base of money supply (or reserved money) is defined as the total amount of cash in circulation and the reserves of individual banks with the central banks. These reserves are established in accordance with any legal requirements on the availability of reserves (required reserves), or exceeds the required level (excess reserves). The base of money supply is related to the total volume of money supply through the so-called money multiplier. The money multiplier is the ratio of money supply to its base, and defines the relationship between this change in the amount of base money supply and a corresponding change in the mass itself.
References
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