Macro economies - Features and Functions of Money and its Significance in Modern Economy PDF

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CHAPTER - 1 [1] Introduction: Money is one of the greatest inventions of man and occupies an important place in the modern economic system. In fact, it is rather difficult to imagine the functioning of a modern economy without the use of money. Whatever may be the form of economy-capitalistic, socialistic, or a mixed economy, the role of money has been well recognised in every economic system. And that is why, modern economy has perhaps been rightly called as money economy, where in all exchanges take place through money, in fact, has entered all aspects of economic life in modern times so much so that the real distinction between means and ends as regards money has vanished. In the words of Dr. Marshall, money is the pivot around which the economic science clusters. Likewise, according to Prof. Crowther, "in the whole commercial side of man's social existence, money is an essential invention on which all the rest is based." There is no phase of human life which has not been affected by the monetary system and there is no aspect of life of the individual or society into which its influence does not reach. In modern times. an essential function of money is to regulate general economic activity and accomplish general social reforms, Money, in fact, acts today as a vehicle of social reform and a cure for economic maladies It acts as a link between the various activities in the economic system; its invention and use has made economic development possible and widened the horizons of economic transactions. In short, money acts as a key determinant of the modern economic system. It will, therefore, be interesting to trace in brief the origin and evolution of money as also to study its nature, functions and significance in modern economy. (2) The Origin and Evolution of Money: Etymologically, the word 'money' has been derived from the Latin word 'Moneta'- the name of Roman Goddess Juno in whose temple, coins were minted in 344 B.C. Money, however, is older than coinage because prior to the introduction of the coinage system different articles like cattle, pigs, teeth, cowrie shells, food grains, tea and tobacco, ivory and iron, gold and silver etc. have been used as money at different times and at different places. The origin of money as such is difficult to trace. It may, however, be said that the development of the institution of money is in a way, 'an epitome of the history of human civilisation" according to Lord Keynes the origin of money is deeply rooted in antiquity. In his well-known work, 'A Treatise on Money', he says, 'Money', like certain other essential elements in civilisation is a far more ancient institution than we were taught to believe some few years ago. Its origins are lost in the mists when the ice was melting, and may well stretch back into the paradisaic intervals of human history of the interglacial periods, when the weather was delightful and the mind free to be fertile of new ideas in the Islands of the Hesperides or Atlantics or some Eden of Central Asia'. The need for money arose out of the difficulties of the barter system of exchange which was prevalent in the primitive: economy. This was the simplest and direct method of exchange where in one commodity or service was exchanged for another commodity or service without the use of money. It continued as long as the requirements of human life were simple and extremely limited as also the area of

CHAPTER - 1 operation was limited. But with the passage of time, as social and economic organisation became more and more complex, as the advantages of division of labour and specialisation became evident and as human wants began to multiply, the difficulties and inconveniences of the barter system of exchange became more and more visible. The main inconveniences of this system were as follows: (a) Lack of double coincidence of wants. (b) Lack of a common measure of value. (c) Lack of a means of subdivision. (d) Lack of store of value. (e) Difficulty in exchange of services. (f) Lack of specialisation. (g) Difficulty in making deferred payments. According to Prof. G.N. Halm, "it is next to impossible that all wishes of bartering individual should coincide as to the kind, quality. quantity and value of the things which are mutually desired, especially in a modern economy in which on a single day millions of persons may exchange millions of commodities and services." In view of the inconveniences of the barter system of exchange, the need was felt to replace it by some more convenient and efficient means of exchange. It was this search for a commodity which could remove the difficulties of the barter system and which could be accepted as a common medium of exchange for goods and services and which could also form as a basis for the measurement and comparison of the values for other commodities that led to the Introduction of money which has been rightly described as, 'one of the most wonderful inventions of mankind.' It would also be interesting to note here that evolution of money has been a secular process. Like several other economic institutions, money in its present form, has passed through several phases and developed over centuries together. Thus, to put it briefly, from barter economy to commodity money, from commodity money to metallic money, from metallic money to paper money and from paper money to bank money, this has been the course of development or trend of evolution of money.' In other words, money in its present form has evolved gradually, through trial and error, over a long time since the dawn of civilisation. Many things from clay and coin to cattle and coins have been used as money from time to time in the various stages of human civilisation. In fact, in modern economy coins and currency is a social phenomenon with a political orientation. However, nobody can say that the process of evolution of money has reached its final stage, because that would mean exhaustion of human ingenuity. [3] Definition of Money:

CHAPTER - 1 Like many other terms in economics, the term money has also been defined in various ways. In fact, to define money in an exact sense is rather a difficult task because money performs many functions and some functions of money are also performed by some assets. The definition of money, as such, cannot be a static one in a modern dynamic society. We, therefore, find different economists holding different views on the most appropriate definition of money Different criteria have been adopted by different economists in defining money Broadly speaking, there are two approaches to the definition of money. (1) The Traditionalist's Approach or The Functional Approach (2) The Empirical Approach. (1) The Traditionalists' Approach or The Functional Approach: In the traditionalist approach, money is defined in terms of its functions and properties. This approach is implicitly based on two criteria of money (a) its general acceptability. (b) Its functional aspects. Thus, for example, Prof. Seligmen defines money as a thing that possesses general acceptability, on the other hand, economists like Walker are of the opinion that money is what money does.' This expression means the anything which performs the function of money is money. Likewise, Hicks in his Critical Essays in Monetary Theory. Says that 'money is defined by its functions According to Hawtrey, money is one of those concepts which like a tea-spoon or an umbrella, but unlike an earthquake on a butter cup, are definable primarily by the use or purpose which they serve Newlyn is, however, more precise when he says that, anything is money which functions generally as a medium of exchange. In fact. general acceptability as a means of payment by all members of society is the sine quanon of any type of money. Money, thus. becomes a social phenomenon on account of its general acceptability Crowther, however, very rightly provides an analytical and illuminating description of money when he defines it as, "anything that is generally acceptable as a means of exchange (that is, as a means of settling debts) and which, at the same time acts as a measure and a store of value". This definition implies that money is anything which performs the following three functions: (a) Serves as a medium of exchange. (b) Serves as a common measure of value.

CHAPTER - 1 (c) Serves as a store of value. To modern economists, however, the crucial function of money is that it serves as a store of value. Anything can be money, provided it is generally acceptable as money. In short, according to the traditional approach, money includes not only paper currency and metallic coins but also the demand deposits of the commercial banks. (2) The Empirical Approach: The empirical approach to the definition of money also known as monetarist approach does not confine the definition of money to mere currencies and demand deposits of banks but also includes a host of financial assets like bonds, government securities, time deposits with banks, treasury bills, equity shares etc, which serve as a store of value. Some economists consider these financial assets as near-money, as distinct from pure money, which they refer to as cash and chequable deposits with commercial banks. The traditionalist approach excludes near-money from the definition of money, while the empirical approach includes it. The empirical definition of money, has been given by monetary economists like Laidler. Kaufman, Fortson, Lee, Hartley, Milton Friedman etc. which seeks the empirical investigation of financial assets. According to them, money is conceived as a cluster of those assets which possess attributes of satisfying one or more criteria of identical behaviour in performing the functions of money. To them, money is what money does. While clustering financial assets into money, they have laid down the following criteria (a) stability of the demand function. (b) high degree of substitutability. (c) feasibility of measuring statistical variations in real economic factors influenced by the monetary policy-which is to be explained through the given cluster of financial assets in the economy To sum up, therefore, it may be said that there is no standard definition of money which can be easily accepted by all; in fact there is hardly a consensus on the proper definition of money. All the same, as Friedman and Schwartz: have righty put it. the definition of money is to be sought for not on grounds of principle. but on grounds of usefulness in organising our knowledge of economic relationship." [4] Functions of Money: The main functions of money can broadly be studied under three heads: (A) Primary Functions (B) Secondary Functions

CHAPTER - 1 money by way of rent, wages, interest, profits, etc. 2. Money Equalises Marginal Utilities/ Productivities: Money helps both the consumers and the producers to maximise their satisfaction. The consumers can equalise the marginal utilities of different commodities purchased with the help of money and get maximum satisfaction. This follows from the law of equi-marginal utility. Likewise, a producer can equalise the marginal productivities of different factors of production in order to maximise his profits. All these are done on the basis of prevailing money prices in the market. In this way, money can ensure maximum satisfaction both to the consumers and the producers. 3. Money as a Basis of Credit System: Modern economy is credit economy. But the main basis of credit in the economy is the monetary system. The supply of credit is to be based on the supply of nominal money. Expansion or contraction of credit is the result of an increase or decrease in the supply of money. Money, thus, forms the basis of the credit system; without a monetary reserve, it is impossible to create credit. 4. Liquidity Function: Since, by definition, money is the most generally acceptable commodity, it is also the most liquid of all resources. It is superior to all assets in terms of liquidity. It is money which imparts liquidity to all types of wealth and distinguishes it from all other commodities. Money is cent percent liquid. (4.1] Static and Dynamic Functions of Money: Dr. Paul Einzig has classified functions of money into static and dynamic functions. The static functions of money are those which facilitate the working of the economy of a country. Thus, the traditional functions of money, namely, medium of exchange, measure of value, standard of deferred payments and store of value are regarded by Dr. Einzig as the static functions or technical functions of money, because without these functions, the economy of a country cannot work in practice. The dynamic functions of money, on the other hand, are those which cause movements in the level of economic activity in an economy through its influence on the price level, volume of production, consumption and the distribution of national income. Changes in the quantity of money bring about changes in the value of money (that is, price level and the rate of Interest which in turn affect the volume of investment, employment, income and saving in the economy. These dynamic functions of money have assumed considerable importance in the determination of economic trends in recent years. A clear appreciation of the dynamic functions of money enables the monetary authority to use money as an engine of economic and social progress. [5] Money as an Asset and the Concept of Near-Money:

We have seen above that money is the most liquid of all assets. It possesses the unique quality of perfect liquidity. No other form of wealth is perfectly liquid.

CHAPTER - 1 Compared to all other assets, money is perfectly marketable or transferable because it actually functions as a medium of exchange. In fact, money is directly expendable and universally acceptable commodity in the discharge of debts and obligations. Again, money possesses relative stability of value also, hence there is capital certainty in money. In short, money is readily expendable, while in the case of other assets, one has to first exchange a given asset for cash which involves a time-lag, cost and even capital uncertainty, Money is directly expendable and universally acceptable commodity in the settlement of obligations; besides money possesses relative stability of value. As a store of value, peoples' preference for money over other assets flows essentially from its liquidity and the uncertainty about the future value of non-money assets. In this context, Keynes very rightly observes that, " the importance of money essentially flows from its being a link between the present and future by acting as a store of value." (5.1] Money and Near- Money Assets: Money assets are those financial assets which are directly acceptable as a means payment like currency notes, coins, demand deposits of commercial banks, etc. However, there are some financial assets which are not money but are like money, for example, time deposits, treasury bills, bills of exchange, deposits of postal savings, units of the Unit Trust, Travellers' Cheques, national savings certificates, shares, bonds, debentures of joint stock companies, etc. These financial assets do not possess cent percent liquidity which money commands. They are, as such, known as near-money or quasi-money assets. Thus, near-money is an asset whose value is fixed in terms of money and which can be easily converted into money, yet it cannot be spent directly as a means of payment. It has to be first converted into money and then used as a means of payment. It should, however, be noted here that both money and hear money assets are claims but near-money assets are not money proper. Coms and currency notes are claims against the State while demand deposits are claims against the commercial banks Near-money is also a claim against some financial institution but money has a special advantage of its own, in that it is superior to all assets in terms of liquidity. (5.2) Distinction Between Money and Near-Money: We may distinguish money and near-money as follows. 1. Money performs the unique function of medium of exchange and general acceptability, while near money by itself is not a means of payment. it has first to be converted into money and then used as a means of payment 2 Money usually refers to coins, currency notes, demand deposits of bank etc, while near-money refers to financial assets like time deposits, bills of exchange, bonds, shares, postal savings deposits, travellers cheques, etc.

CHAPTER - 1 each member of society to ensure that the means of enjoyment to which he has access yield him the greatest amount of actual enjoyment which is within his reach." However, a superficial view of the nature of money has led some thinkers to comment that money, by itself, is of no importance. Thus, it has been said that, 'money is a wrapper in which goods come to you...... 'money is the garment wrapped around the body of economic life'... money is a veil behind which the action of economic forces is concealed.' These statements, however, do not do justice to the important functions which money performs. Let it be remembered that money promotes specialisation, enables production to take place in advance of consumption and thereby facilitates the planning of both production and consumption. As Pigou points out, the institution of money is an extremely valuable social instrument making a large social contribution to economic welfare... money is not merely a veil or a veil garment or a wrapper. Likewise, Goldenwieser also remarks, in spiritual welfare, the proper volume and distribution of money may be a secondary factor or no factor at all, tin shaping economic well-being, it is a powerful force. [7] Evils of Money and Need for Control: Although money plays a vital role in the modern economic system, it is not an unmixed blessing. There are certain evils of money as well which tend to nullify its merits. (1) Economic Instability: As is well known, the value of money seldom remains stable, it fluctuates from time to time and as a result money falls to perform its function as a measure and a store of value. Frequent changes in the value of money are reflected in the changes in general price level leading to Inflationary and deflationary situations. Both inflation and deflation are evils and are harmful for the health of the economy Thus, indiscriminate changes in the value of money cause economic instability with all its attendant evils. (ii) Over- Capitalisation and Over- Production: As said earlier. money has facilitated the process of borrowing and lending. Now, the case with which these borrowing and lending operations are carried on has given rise to the twin problems of over capitalisation and over- production. This implies that, some industries tend to utilise more capital than is necessary. Over capitalisation results in over production leading to economic instability with its adverse effects on economic development. (iii)Money Strengthens Capitalism: Money strengthens and reinforces capitalism. In fact, money is said to be the basis and root of capitalist production, The growth of money and credit makes capitalists more powerful, capital gets concentrated in a few hands and this gives rise to glaring inequalities of income and wealth in the society. The concentration of capital in the hands of a few powerful makes them exploit ab and accumulate surplus value on the basis of which there is fun her expansion of capitalism....