Let’s start this thread by defining money – since it seems its definition is often assumed, but seldom understood.
The late 19th century American economist, F.A. Walker, defined money with the phrase, “money is that money does.” This phrase illustrates that there is no “a priori” definition of what should, or could, be money. The textbook definition of money is more of a description of money’s attributes: money is anything that serves as a medium of exchange, a store of value, a unit of account, and a standard of deferred payment, which, ultimately means that money is anything that serves the functions that have commonly been attributed to money. I prefer Walkers definition.
To further complicate the issue, if one can convert an asset into “money” at zero transaction costs, then that asset is effectively money. An alternate way to think about money is to separate money into “outside” money, which forms the monetary base, and “inside” money which are money substitutes, i.e. assets that can be converted into base money with little or no cost, or are readily accepted as a means of payment. The financial industry has been quite effective and “monetizing” assets such as demand deposits, and each innovation made by the industry reduces the demand for the monetary base (this is an important fact for determining the purchasing power of base money). It s important to note that the Federal Reserve directly controls only the monetary base, but does have some influence over the creation of inside money through interest rate manipulation.
The “money supply” is thus a collection of assets (some of which are someone else’s debt) of varying degrees of marketability and redeemability (for base money). The Federal Reserve categorizes these assets into four sets:
M0 – the monetary base.
M1 – redeemable for base money and de facto negotiable (meaning they are readily accepted as a means of payment).
M2 – redeemable but not negotiable.
M3 – not redeemable but negotiable (meaning there are active secondary markets, of high liquidity, for these assets). |
