2.5.1a Functions of money

Barter needs a double coincidence of wants

1. Without money, people must barter, trading goods or services directly for other goods or services.
2. A swap only works if there is a double coincidence of wants, so finding a match wastes time and many useful trades never happen.
3. Barter has no common measure of value, so working out how many eggs a haircut is worth is difficult.
4. Goods used in barter can be hard to store and divide, so a farmer cannot easily save a cow or spend half of it.

Money performs four separate functions

1. Medium of exchange: money is accepted by sellers in return for goods and services, so it removes the need for a double coincidence of wants.
2. Store of value: money holds its worth over time, so people can save now and spend later.
3. Unit of account: money gives a common measure of value, so the price of every good can be compared in pounds and pence.
4. Means of deferred payment: money lets people agree to pay in the future, so borrowing, lending and paying in instalments become possible.

Each function solves a problem that barter cannot

1. The medium of exchange function ends the search for a double coincidence of wants.
2. The unit of account function gives the single measure of value that barter lacks.
3. The store of value function lets people hold wealth over time instead of holding goods that may spoil.
4. The means of deferred payment function makes credit and future contracts reliable.

Money makes exchange more efficient

1. Because sellers accept money, trade is quick and buyers no longer need to find a matching swap.
2. This lower cost of trading encourages specialisation, where people focus on one job and buy everything else with the money they earn.
3. Specialisation raises output and living standards, so an economy that uses money can produce far more than one relying on barter.

2.5.1b Definition of money

Money is more than notes and coins in circulation

1. Cash makes up only part of the money used in a modern economy such as the UK's.
2. Bank deposits can be spent at any time, by card, by transfer or online, so they work as money even though no cash changes hands.
3. This is why money is defined more broadly than just notes and coins: it also includes the balances people hold in current and savings accounts.
4. When someone pays by contactless card or bank transfer, ownership of a bank deposit moves from the buyer to the seller instead of physical cash being handed over.

Bank deposits work as money too

1. People pay for goods and services either by handing over cash, or by transferring money held as a bank deposit.
2. When a deposit is used, the bank moves the balance from the buyer's account to the seller's account electronically.
3. Banks such as Barclays and NatWest use the Faster Payments system to move deposits between UK accounts within seconds.
4. Because deposits can be moved so easily, most spending in a modern economy uses bank money rather than notes and coins.
5. The Bank of England has reported that bank deposits make up around 97 per cent of broad money in the UK economy, with cash making up only about 3 per cent, a figure it published for December 2013 that still illustrates how small a share cash represents.

2.5.2a Agents in the financial sector

The financial sector moves money from savers to borrowers

1. Its main job is to channel funds from people with spare money to people who want to borrow.
2. Savers put aside money they do not need to spend now and earn interest on it.
3. Borrowers use that money to buy homes, start firms or fund spending, and pay interest in return.
4. By linking the two sides, the sector turns idle savings into useful investment.

Three main agents make up the financial sector

1. The central bank is the government's own bank and watches over the whole system, with the Bank of England as the UK's example.
2. Commercial banks such as Barclays and Lloyds Bank are the high street names most people bank with day to day.
3. Building societies such as Nationwide and Skipton exist alongside them, offering similar accounts and mortgages but under member ownership.

A building society differs from a bank in ownership

1. A commercial bank is owned by shareholders, who expect a return in the form of dividends and a rising share price.
2. A building society is owned by its members, meaning its own savers and borrowers, so it has no outside shareholders.
3. Because a building society has no shareholders to pay, any surplus can be used to offer better rates or lower charges to members instead.
4. Nationwide Building Society is the largest building society in the UK, run for the benefit of its members rather than outside investors.

Spot the institution by what it mainly does

1. Ask who owns the institution: a building society is member owned, a commercial bank is owned by shareholders, and the central bank belongs to the state.
2. Ask whether it deals with the public or with the wider system, because only the central bank oversees the other agents rather than serving individual customers.

2.5.2b The role of the Bank of England

The central bank runs the money system

1. In the UK this is the Bank of England.
2. One of its jobs is issuing currency, meaning it is responsible for the notes and coins in circulation.
3. It acts as banker to the government, holding the government's main accounts and helping manage its borrowing.
4. It does not offer accounts or loans to the general public.

It sets Bank Rate through the Monetary Policy Committee

1. The MPC meets eight times a year, roughly every six weeks, to decide whether to raise, cut or hold Bank Rate.
2. As of 30 August 2026, Bank Rate stands at 3.75 per cent, after being cut from 4.00 per cent on 11 December 2025 and held at every meeting since.
3. The MPC's next scheduled decision is 17 September 2026.
4. The Bank of England's target is to keep CPI inflation at 2.0 per cent a year, so the MPC raises Bank Rate when inflation risks running too high and cuts it when the economy needs support.
5. How a change in Bank Rate then feeds through to spending, borrowing and inflation is covered in the monetary policy topics, so this page focuses on the Bank's own role rather than that chain.

It safeguards the whole financial system in a crisis

1. The Bank of England acts as the lender of last resort, lending to banks that cannot borrow money elsewhere.
2. This stops a short-term cash shortage at one bank turning into a wider collapse of the banking system.
3. The Bank also works more broadly to keep the whole system stable, a role called financial stability.
4. A stable system means households and firms can trust that their money and their bank are safe.

Its two roles reinforce each other

1. Setting Bank Rate lets the Bank respond to inflation, while acting as lender of last resort lets it respond to a banking crisis.
2. Together these two roles are why the Bank of England is often described as the guardian of the UK's monetary and financial system.

The Bank of England influences the economy through Bank Rate, and protects it through financial stability.

2.5.2c The role of high street banks

Commercial banks take in deposits and lend them out

1. A commercial bank, also called a high street bank, serves households and firms who need everyday banking.
2. Its first job is accepting deposits, keeping customers' money safe in current and savings accounts.
3. Its second job is making loans: to firms that need finance for investment, and to households, for example through a mortgage to buy a home.
4. Banks make a profit from the gap between the interest they charge borrowers and the interest they pay savers.
5. By lending to firms, banks help fund investment in machinery, buildings and stock.

They also run the payments system we use daily

1. Banks provide a payments system that lets money move without cash changing hands.
2. This includes debit cards, direct debits and online transfers.
3. Banks such as Barclays and NatWest use the Faster Payments system to move money between UK accounts within seconds.
4. A reliable payments system lets consumers buy goods quickly and safely, and lets producers pay wages and suppliers and receive money from customers.

Banks link savers, borrowers and investment together

1. Savings accounts let households store money safely and earn interest.
2. Loans let firms fund the investment needed to grow, buy equipment or open new sites.
3. By connecting savers to borrowers, high street banks turn idle savings into active investment across the economy.

High street banks fund investment by lending out the money that savers deposit with them.