Money is anything widely accepted for payments, serving as a medium of exchange, a unit for counting value, and a way to store wealth.

Where the Word 'Money' Comes From

Key idea: The word 'money' has ancient roots, tracing back to Roman coin making and the goddess Juno.

The word 'money' comes from the Latin word 'moneta,' which means 'coin.' This Latin word is thought to have come from a temple in ancient Rome dedicated to the goddess Juno. This temple was where Roman coins were made.

In the past, people also used the word 'specie' for coin money. This came from a Latin phrase meaning 'in kind,' referring to money that was valuable in itself, like gold or silver coins.

A Quick Look at Money's History

Key idea: Money has evolved from barter, to commodity money, to representative money, and finally to the fiat money systems we mostly use today.

For a very long time, people traded goods and services without using money. This is called barter. While barter might have happened between strangers, societies mostly used a 'gift economy,' where people gave things to each other and kept track of who owed whom favors.

Many cultures eventually started using commodity money. For instance, in ancient Mesopotamia around 3000 BC, people used 'shekels,' which were units of weight for things like barley. Other cultures used shells, like cowry shells, as money.

The Lydians, an ancient people, are believed to have been the first to use gold and silver coins around 650 to 600 BC. These coins were stamped to show their weight and purity.

Later, people started using 'representative money.' This was like a receipt from a gold merchant or bank that said you had deposited gold. These receipts eventually became accepted as payment themselves. Paper money, or banknotes, first appeared in China during the Song dynasty, evolving from promissory notes. These were used alongside coins.

In Europe, paper money became known through travelers like Marco Polo in the 13th century. It was first issued in Europe in Sweden in 1661. The gold standard, where paper money could be exchanged for a fixed amount of gold, became common in the 17th to 19th centuries.

After World War II, many countries tied their money to the US dollar, which was then tied to gold. But in 1971, the US stopped allowing its dollar to be directly exchanged for gold. After this, most of the world's money became fiat money, meaning its value is based on government trust and its ability to be used for payments, not on being backed by a physical commodity like gold.

“Most of the world's money became unbacked by anything except the governments' fiat of legal tender and the ability to convert the money into goods via payment.”

The Three Main Jobs of Money

Key idea: Money performs three essential functions: it simplifies trade, measures value, and allows wealth to be saved.

Money has three main jobs, sometimes called its 'functions.' These jobs help our economy run smoothly.

First, money acts as a medium of exchange. This means it makes trading goods and services much easier. Imagine you want to trade your apples for someone's shoes. Without money, you'd have to find someone who has shoes AND wants apples. This is called the 'coincidence of wants,' and it is hard to find. Money solves this problem because you can sell your apples for money, and then use that money to buy shoes from anyone who accepts it.

Second, money is a unit of account. This means it provides a common way to measure the value of different things. Instead of saying 'this car is worth 10 cows and 50 chickens,' we can say 'this car is worth 20,000 dollars.' This makes it easy to compare prices and keep track of economic activity.

Third, money is a store of value. This means you can save money today and use it to buy things in the future. For money to be a good store of value, its buying power should stay fairly stable over time. If prices go up quickly (inflation), money loses its value, making it a less effective store.

Some older definitions also included 'standard of deferred payment,' which means money is an accepted way to pay back debts in the future. However, most modern textbooks now include this idea within the other three functions.

What Makes Good Money?

Key idea: Effective money must be fungible, durable, divisible, portable, acceptable, and scarce to function properly.

For money to do its jobs well, it needs certain qualities:

It must be fungible, meaning one unit of money is exactly the same as another. For example, one dollar bill is worth the same as any other dollar bill.

It needs to be durable, so it can be used many times without falling apart.

It should be divisible, meaning it can be broken down into smaller units for smaller purchases.

It must be portable, easy to carry around and transport.

Most people must acceptable it as payment.

Finally, it needs to be scarce. If everyone could just print their own money, it would quickly lose its value.

How We Measure Money: The Money Supply

Key idea: The money supply measures all available money in an economy, categorized by how easily it can be spent, and banks play a key role in creating it through loans.

The total amount of money available in an economy is called the money supply. This includes all the cash, as well as money held in bank accounts like checking and savings accounts.

Economists measure the money supply using different categories based on how easily the money can be used. These are often called M1, M2, and M3.

M0 is the most basic money, which is the physical cash created by the central bank.

M1 includes all the physical cash plus money in checking accounts. This is the most 'liquid' money, meaning it is easiest to spend.

M2 includes M1 plus money in savings accounts and smaller time deposits.

M3 includes M2 plus larger, less liquid deposits. The exact definitions can vary by country.

It is a common mistake to think that banks only lend out money that savers deposit. In reality, banks create new money when they give out loans. When a bank approves a loan, it creates a new deposit in the borrower's account. This new deposit is new money in the economy.

Different Types of Money

Key idea: Money exists in various forms, from commodity based to government backed fiat money, and increasingly as digital records.

There are different kinds of money that have been used throughout history and are still used today.

Commodity money is money that has its own value because it is made of a valuable material. Examples include gold, silver, or even things like salt or shells. The value comes from the commodity itself.

Representative money is like a certificate or paper note that can be exchanged for a fixed amount of a commodity, such as gold. Its value is tied directly to the commodity it represents.

Fiat money is what most countries use now. Its value comes from a government's order or 'fiat' that it must be accepted as legal payment. It is not backed by a physical commodity. Paper money and coins today are examples of fiat money.

Commercial bank money is the money that exists in your bank accounts, like checking or savings. It is not physical cash but rather numbers in a bank's computer system. This type of money makes up the largest part of the money supply in many developed countries.

Digital money is money represented electronically. Most money today exists as digital records in bank databases. This includes things like online payments and even cryptocurrencies like Bitcoin, which operate without traditional banks or governments.

Managing Money: Monetary Policy

Key idea: Central banks use monetary policy to manage the money supply and interest rates, aiming for economic stability and growth.

Monetary policy is how a country's central bank manages the money supply and interest rates to influence the economy. The goal is often to keep prices stable, encourage employment, and promote economic growth.

When money was tied to gold, the money supply could only grow if more gold was found. This could lead to periods of inflation (when gold became less valuable) or deflation (when gold became more valuable).

Today, with fiat money, central banks have more control. They can change interest rates, buy or sell government bonds (called 'open market operations'), and adjust how much money banks must keep in reserve. These tools help them try to achieve their economic goals.

A central bank's actions are very important. If monetary policy fails, it can lead to serious problems like hyperinflation (prices rising extremely fast) or a deep recession (a severe economic downturn).