What is Money?
In this article we will explore the meaning of money, its different forms, how it is created, and the role of central banks in the process.
Let us start with a basic question:
WHAT IS MONEY?
Money has three main characteristics:
- It is a unit of account to make it easier to buy and sell goods and services,
- it provides a common measure of value, allowing prices to be compared,
- It acts as a store of value, enabling spending now or in the future.
FORMS OF MONEY
Money has taken many forms throughout history.
Today, it appears as coins, paper notes, plastic cards and electronic formats. While cash is still used widely, money held in electronic form in deposits with commercial banks is more important in modern economies. Commercial banks also hold money in the form of electronic balances with central banks. Money may also be stored on cards or digitally, for example on mobile apps.
The European Central Bank (ECB) is developing a digital euro to complement euro banknotes and coins. Once launched, this should ensure that central bank money remains relevant in all transactions – whether in person, in stores, online or offline.
HOW IS MONEY CREATED?
Money is created in two main ways: by central banks and by commercial banks.
Central banks create central bank money. They print banknotes and mint coins. They also create electronic reserves for commercial banks, through monetary operations or asset purchases. Central bank money is the safest form, carrying no credit risk; unlike money created by other issuers.
However, most money in use is created by commercial banks. When a bank gives its client a loan, it credits the client's account, creating money. The ability to convert commercial bank deposits into central bank money gives the public the confidence to hold them and ensures that payments can take place smoothly.
THE ROLE OF THE CENTRAL BANK IN THE CREATION AND SUPPLY OF MONEY
Although most of the money in bank accounts comes from the activities of private banks, central banks have a key role in the creation and supply of money and, more importantly in maintaining its value over time.
The primary goal of central banks in modern economies is that of maintaining price stability. In the Eurosystem, price stability is defined as a year-on-year increase in the general price level of 2%. To achieve this goal, the ECB sets interest rates and uses other tools to influence the cost of money and the demand for goods and services.
Higher interest rates encourage savings, reduce demand and put downward pressure on prices. Too much money, or low interest rates, can boost demand, pushing inflation higher and eroding the value of money over time.
Central banks use interest rates and other tools as a lever to steer inflation towards their target. They regulate and oversee the infrastructure that is used to move money in the economy.
They also collaborate with other authorities and with institutions that handle cash to ensure that notes and coins in circulation are genuine, fit and sufficient to meet demand.
CONCLUSION
Money is more than the cash in your wallet
It is a complex system involving different types of money, created in various ways, and backed by central banks to enable citizens to pay with confidence and efficiency.
