Descriptive Definitions of Money

Most definitions of money in the economics literature indicate money’s role as a medium of exchange, unit of account and store of value with the principal emphasis being on its function as a medium of exchange.

Any asset Opens in new window that performs the role of a medium of exchange is generally held to be able also to act as a store of value and a unit of account.

Hicks (1967) denied this, arguing that money could be a medium of exchange without being a store of value as long as, over the course of a day’s trading, no individuals have sold more than they have bought and vice versa.

However, this would be a very special case and the usual view is that all forms of money are stores of value, whereas the reverse is not true (see Harris, 1985). Thus, acting as a medium of exchange is taken as the only role that clearly sets money apart from other assets.

Our discussion so far, however, alerted us to a problem with the notion of money as a medium of exchange since credit acts as a medium of exchange but is almost always excluded from definitions of money.

One way out is to follow Shackle (1971) and distinguish between the medium of exchange (which includes credit) and a means of payment, in the sense of a means of final settlement of debt. It is this latter idea that most writers have in mind.

The Ultimate Managed Hosting Platform Expressions along these lines commonly used in textbooks include:
  • a temporary store of purchasing power;
  • an asset that gives immediate command over goods and services;
  • a property right generally acceptable in exchange.

These are descriptive or a priori definitions of money which do not give a precise idea of which assets should be included in a measure of the economy’s money stock.

Everything depends on what is ‘generally acceptable’.

Nonetheless, the concentration on the role of money as a means of payment led to the common acceptance of the ‘narrow’ view of money as an asset that would be held only temporarily and not as a form of savings.

That is, economic agents will not choose to hold money for any reason other than to participate in exchange.

This, in turn, led to the distinction between narrow money and other financial assets based on whether or not interest was paid on them.

Banks were assumed not to need to pay interest on deposits that were only being held to allow people to purchase goods and services in the immediate future. Interest bearing assets might relatively easily be converted into money but might also be held as part of savings.

Until the middle 1980s, this gave a neat set of assets consisting of notes and coin (outside money or the monetary base) plus non-interest bearing deposits with banks (‘sight’ or chequeable deposits). Sight deposits with banks are part of ‘inside money’ because they are both created by and held within the private sector.

The Ultimate Managed Hosting Platform There are two obvious problems with the narrow definition of money.

Firstly, its justification is that all other assets must be converted into notes and coin or sight deposits in order to carry out exchange.

However, other types of bank deposits and deposits with non-bank financial institutions can be converted so quickly (and at virtually no cost) into narrow money that the distinction is hardly worth maintaining.

This has been true for many years but is all the more true when funds can be moved from one account to another through the internet or by telephone at any time of the day or night.

Indeed, some banks now offer sweep facilities that transfer funds automatically between low interest current accounts and other higher-interest accounts. Equally, other assets do not need to be sold to obtain narrow money but can be used as collateral for a loan that takes the form of narrow money.

Under these circumstances, many types of asset are as good as narrow money for the purpose of exchange. Certainly, if our interest lies in the notion of a lack of money acting as a constraint on expenditure or as influencing expenditure plans, the distinction between narrow money and other highly liquid assets is not worth maintaining.

This justifies the widening of the standard definition to include bank deposits other than sight deposits. However, once one moves away from the strict interpretation of means of final settlement of debt and includes liquidity as a criterion it becomes impossible to draw a line between assets that are money and those that are nearly money but not quite.

The issue was slightly complicate by the move to the payment of interest on sight deposits in the 1980s since that raised the question of whether some sight deposits might be savings rather than being held because of the function of sight deposits as means of payment. In fact, this merely emphasized a problem that had always existed in the distinction between deposits held for transactions purposes (money) and those held as savings.

One only has to acknowledge that people do not know with certainty either the total future value of their wealth or the precise value of the transactions they will be undertaking to realize that the distinction is dubious.

Some assets provide convenience because they are acceptable as means of payment or can be easily converted into means of payment. Banks offer a lower rate of interest on these assets because they are more likely than other types of deposit to be withdrawn at no notice and so banks are less able to make profits from funds deposited with them in this form.

Depositors are prepared to accept a lower rate of interest on these assets because of their convenience. What is important is the interest rate differential between assets of differing degrees of liquidity. The attribution in the past of some special significance to the fact that sight deposits paid no interest simply gave a false security to the distinction between them and other kinds of bank deposits.

The second obvious problem with the narrow definition of money is that it ignores the significance of the idea that to be a means of payment, an asset must be generally acceptable. Since acceptability depends on customs and the nature of financial institutions, what is and is not money differs from economy to economy and changes over time.

This leaves us in the position that the narrow definition of money is too limited and does not reflect the complexity of influences on decisions regarding the form in which to hold wealth.

However, broader definitions of money are insufficiently precise because there are no clear criteria for deciding what should be included and what left out.

Milton Friedman is widely quoted as saying ‘money is what money does’, implying that anything can be counted as money that performs the role of money. This does not take us very far as a descriptive definition of money.

There have been attempts to resolve this issue by making use of the ‘revealed preferences’ of money-holders. This is a microeconomic approach that works on the principle that the best way to find out which assets are money is to discover which assets people treat as money.

We start with a narrow definition including only assets that everyone would agree from part of the money stock (notes and coins) and then seek to discover by studying household economic behavior which other assets are treated as sufficiently close substitutes for the original set that they are , to all intents and purposes, equivalent to money. This leaves open what is meant by a ‘sufficiently close substitute’ and so remains subjective.

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