Functions, Classifications, Desire and Offer in Economic Perspective: Currencies Explained
In the world of finance, money serves three primary functions: medium of exchange, store of value, and unit of account. But what makes money effective and how is it created? Let's delve into these questions.
For money to function optimally, it must be widely accepted, have a clear value, be divisible, durable, portable, and easily verifiable. This acceptance extends to both physical currency and digital money, including banknotes, coins, and electronic funds.
The demand for money is driven by three motives: transactional, precautionary, and speculative. The transaction motive depends on the average transaction size and the overall GDP, while the speculative motive is related to the perceived returns and risks from holding other financial instruments. The precautionary motive reflects savings for unforeseen circumstances, opportunities, or immediate expenses.
The money supply is determined by the central bank, which uses various methods such as policy rate, open market operations, and reserve requirements. However, the money multiplier, a crucial factor in money creation, is influenced by several factors.
The money multiplier is calculated as the reciprocal of the reserve requirement ratio. This ratio determines how much of a bank's deposits must be kept as reserves and not lent out. A higher reserve requirement means banks lend less of their deposits, reducing the money multiplier.
Banks' excess reserves, the public's preferences for cash versus deposits, banks' willingness to lend, and currency holdings by the public also impact the money multiplier. Changes in these factors can lead to fluctuations in the money supply.
It's important to note that the Federal Reserve cannot precisely control the money supply by adjusting reserve requirements alone, as it cannot dictate banks' excess reserves or the public's currency holdings.
Fiat money, such as banknotes and coins, has replaced the gold standard in today's economy. This allows governments to benefit from seigniorage, the profit earned from creating new money. Fiat money also provides a general measure of the value of goods and services exchanged, making comparisons easier and facilitating efficient decision-making.
As we move forward, it's fascinating to observe the rise of electronic money and cryptocurrency, which are gaining popularity and replacing physical money for some transactions. Gold, with its resistance to inflation, remains a valuable asset and a safe haven in uncertain economic times.
In conclusion, understanding the money multiplier and its role in the economy is crucial for grasping the intricacies of monetary policy and the broader economic landscape. By mastering these concepts, we can make more informed decisions about our financial future.
[1] Economics Online. (n.d.). Money Multiplier. Retrieved from https://www.economicsonline.co.uk/money_and_banking/money_multiplier.html [2] Investopedia. (2021, March 15). Money Multiplier. Retrieved from https://www.investopedia.com/terms/m/moneymultiplier.asp
- In the realm of business and finance, the money multiplier, calculated as the reciprocal of the reserve requirement ratio, plays a significant role in determining the money supply, impacted by factors such as banks' excess reserves, the public's preferences for cash versus deposits, banks' willingness to lend, and currency holdings by the public.
- As digital money, electronic funds, and cryptocurrency continue to gain traction in the business world, understanding the money multiplier is essential for navigating the intricacies of monetary policy, enabling individuals to make informed decisions about their financial future.
