2.4.1a Money and the money supply (A-level only)

Money Works Because It Performs Four Functions and Has the Right Characteristics

1. Money is anything widely accepted in payment for goods and services.
2. It has four functions: a medium of exchange, a unit of account, a store of value and a standard of deferred payment.
3. Money removes the need for a double coincidence of wants found in barter.
4. Good money is durable, portable, divisible, acceptable, scarce and uniform.

Money Serves as a Medium of Exchange, a Unit of Account, a Store of Value and a Standard of Deferred Payment

1. As a medium of exchange, money is accepted in payment for goods.
2. As a unit of account, it lets prices be compared on one scale.
3. As a store of value, it holds purchasing power over time.
4. As a standard of deferred payment, it allows borrowing and lending over time.

Good Money Is Durable, Portable, Divisible, Acceptable, Scarce and Uniform

1. Durability and portability let money be kept and carried easily.
2. Divisibility lets it pay for goods of many different values.
3. Acceptability and uniformity mean everyone will take it and trust it.
4. Scarcity keeps money valuable, so an over-issue erodes its worth.

An Asset Works as Money Only If It Meets the Functions and Characteristics

1. An asset works as money if it meets the functions and characteristics.
2. It fails if it cannot store value or is not widely accepted.
3. So each feature can be tested against a candidate asset.
4. This explains why some assets serve as money and others do not.

Match Each Characteristic to the Function It Supports

The Money Supply Splits Into Narrow and Broad Money by Liquidity

1. The money supply is the total stock of money in the economy.
2. Narrow money is notes, coins and operational deposits used as a medium of exchange.
3. Broad money is narrow money plus less-liquid savings and time deposits.
4. The distinction rests on how liquid each type of money is.

Money Can Be Ranked From Most to Least Liquid

1. Cash and current-account deposits can be spent at once.
2. Savings and time deposits must first be moved or matured.
3. So deposits can be ranked from most to least liquid.
4. Narrow money captures the most liquid, broad money a wider set.

Narrow Money Tracks Spending While Broad Money Reflects Bank Lending

1. Narrow money is closest to spending in the economy.
2. Broad money reflects the wider lending of the banking system.
3. Broad money is harder to control because banks create most of it.
4. So the two aggregates give different signals about the economy.

Classify Deposits by Liquidity Into Narrow or Broad Money

1. Place the most liquid items in narrow money.
2. Add less-liquid deposits to reach broad money.
3. Rank deposits rather than treating them as identical.
4. So the classification follows liquidity throughout.

Define Each Aggregate by Its Liquidity

2.4.1b Financial markets, assets and bond prices (A-level only)

The Financial Sector Channels Savings Into Productive Investment

1. The financial sector channels savings into investment.
2. It lets savers lend to firms and individuals who want to borrow.
3. Banks act as intermediaries between savers and borrowers.
4. Efficient intermediation supports investment and growth.

The Sector Lends, Enables Payments, Provides Markets and Manages Risk

1. It facilitates saving and lends to firms and individuals.
2. It facilitates the exchange of goods and services through payments.
3. It provides forward markets in currencies and commodities.
4. It provides a market for equities and helps assess and manage risk.

Intermediation Turns Idle Saving Into Productive Investment

1. Savers rarely know the firms that need funds.
2. Banks pool saving and pass it on as loans.
3. This turns idle saving into productive investment.
4. More investment can raise the economy's capacity and growth.

The Sector's Role Reaches Well Beyond Storing Deposits

1. The sector connects those with funds to those who need them.
2. It supports spending, investment and the management of risk.
3. When it works well, it lifts investment and growth.
4. So its role reaches well beyond simply storing deposits.

Stress Intermediation and Its Link to Growth

The Money, Capital and Foreign Exchange Markets Each Serve a Different Need

1. The money market is for short-term borrowing and lending.
2. The capital market is for long-term finance through bonds and shares.
3. The foreign exchange market is where currencies are traded.
4. Firms raise funds through debt or through equity.

Each Market Serves Short-Term, Long-Term or Currency Finance

1. The money market deals in short-term funds and liquidity.
2. The capital market raises long-term funds for investment.
3. The foreign exchange market lets firms buy and sell currencies.
4. Each market serves a different financing need.

Debt Is Repaid With Interest While Equity Gives Up Ownership

1. Debt must be repaid with interest whatever the firm earns.
2. Equity gives up a share of ownership and future profit.
3. Debt raises fixed costs but keeps ownership intact.
4. Equity avoids repayment but dilutes control.

When Market Interest Rates Rise, Bond Prices Fall

1. A bond pays a fixed coupon each year, so its yield depends on its price.
2. A government bond also has a maturity date, the point at which the issuer repays the bond's face (par) value to the holder.
3. When market interest rates rise, newly issued bonds pay more, so existing bonds become less attractive.
4. The price of existing bonds falls until their yield matches the higher market interest rate.
5. So when market interest rates rise, bond prices fall: the two move inversely.

Keep the Terms Straight