What Economic Functions Does Money Perform & How Is Money Supply Measured

 What Economic Functions Does Money Perform?

If we can go back to the age of where the money does not exist, we will face many issues with exchanging goods and meeting our daily needs. Suppose you are hungry right now and looking for food. You basically have two options, to hunt, to plant, and cook all by yourself. Or, you can make a deal with everyone who can provide the food to you. But the problem is, you have to figure out what goods do the other people want and then try to get these goods. The processes can take days or even months. This leads to the first primary function of money, a medium of exchange. You don't have to own the goods that other people want, instead, you just give them the money, the medium of exchange. And they can use it to exchange what they want. 

However, we have not solved the problem. The second issue is how much money or how many units do I need to give for the goods I want? This is one of the important functions of money, a unit of account. Despite the price tag may be different, we can choose to accept or refuse. This topic is always a controversial one because how much money we should spend, or how much we can spend on a certain good is very depends on how much income we can earn and how much money we have saved.

As we mentioned how much money we have saved, we mention that a good we can store for future spending. For centuries, we use gold as a unit to exchange goods. The reason was, physically, gold does not rust or change over time. If a good is easy to change its weight or apparel, people will get confused and refuse to accept it as a medium of exchange. Therefore, money has to be storable and it is a store of value. After all, we don't want to accept an unstorable good as a medium of exchange and worry it will expire or go bad day by day.

The last thing I wanna talk about is, I think today's medium of exchange, known as currencies, is build on trust. If you trust the paper, the stone, or any other goods that can store and do not losing its value over time, you may more likely to accept it. Many governments around the world do not earn the trust of their people, so their people tend not to hold the currencies they issued. 

How Is Money Supply Measured?

There are various types of money. And they are generally classified as M0, M1, M2, and M3, according to the type and size of the account in which the instrument is kept. 

As the numbers, 0, 1, 2,3 represent the different types and sizes, M0 is the basic money and much more original. We touch, count, and spend it every day. It includes Federal Reserve notes, Treasury coins, and bank reserves. The first two types are already in our everyday life. But what is the bank reserves? It is the deposits with the Federal Reserve by banks. It is the money equivalents that can be converted easily to cash.

M1 is M0 plus travelers’ checks and demand deposits. The additional travelers’ checks and demand deposits represent the different types of liquidity and spendability in the economy. For example, you can pay the same $100 with travelers' checks, notes, coins, or your demand deposits. The notes and coins are already in your wallet, and can be accepted immediately. But if you want to pay with your travelers' checks or demand deposits, sellers probably have to confirm with the issuer or the bank first. That means you have to move your deposit from the bank.

The same logic, M2 is M1 plus additional types of money, short-term time deposits in banks, and certain money market funds. And short-term time deposits, certain money market funds are more unmoveable than M1 which means you and the seller will have to wait for a more long time to complete the deal.

M3 includes M2 in addition to long-term deposits. However, M3 is no longer included in the reporting by the Federal Reserve. According to a statistical release article published by the Federal Reserve, states that the M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. 

Why? 

The reason why money is measured and classified by M0, M1, M2, and M3 because that reflects the different types of liquidity and spendability in the economy. 

Reference

Chappelow, J. (2020, August 02). Money Supply Definition. Retrieved September 05, 2020, from https://www.investopedia.com/terms/m/moneysupply.asp

Discontinuance of M3. (2006, March 9). Retrieved September 05, 2020, from https://www.federalreserve.gov/releases/h6/discm3.htm