Monetary Policy
Once upon a time, settlers moved westward from the eastern United States. Before the move out West, the settlers had to
choose which belongings to take and which to leave behind. Some converted their possessions into gold. This strategy not
only allowed them to travel “light,” it also ensured that they didn’t advertise their belongings. Nevertheless, as the settlers
headed West, they sometimes encountered individuals who were after the gold they were carrying. Over time, this became
a problem for settlers because they were easy targets for robbery and theft. To prevent theft and minimize the likelihood of
losing their fortune, settlers began leaving their gold with blacksmiths along the route. Blacksmiths would give the settlers
a receipt for the gold and, for a nominal fee, guard the gold until the settlers had some use for it. When the settlers reached
their destinations, instead of backtracking for their gold they would exchange their receipts for purchases. In time, the
receipts acted as currency for the settlers because their gold was inaccessible. Meanwhile, the blacksmiths had all of this
idle gold. They began making loans to other settlers for a mutually agreed-upon interest rate and time period. In this way,
the blacksmiths and the settlers became pioneers of the U.S. banking system.
Money is anything that is generally acceptable to sellers in exchange for goods and services. You can use the cash you
have on hand to go to a Dodgers game or to purchase a movie ticket. All you have to do is present your money to the
cashier, who readily accepts it. If you wanted to use your Dodgers ticket to buy a movie ticket, the exchange would be
a little more complicated. You would probably have to sell the ticket before you could use it to buy other goods and ser-
vices. Because goods aren’t generally acceptable means of paying for other goods and services, we don’t consider them
money. Money is the most liquid asset, an asset that can be easily exchanged for goods and services.
While the validity of the old saying “money is everything” is debatable, in this chapter money iseverything. So far in
this book we’ve reviewed concepts of supply and demand, unemployment, inflation, and government spending with an
understanding that each one involves money. Money, in essence, is a medium of exchange. People use money to satisfy
their needs and wants. Earlier in the book, we talked about choices and how everything revolves around choices. Now
we shift our attention to what happens afteryou’ve made a choice. How will you pay for this choice, and does it have a
monetary value? To establish order, routine, and value, societies have accepted money as a medium of exchange. In this
chapter, we focus on how money travels, who controls it, and what role it plays in a market economy.
The Three Functions of Money
Some people might think that money’s function is limited to one use (to buy things), however, money actually has three
functions that make it a practical form of payment. These three functions allow money to be durable, exchangeable and
valuable.
■ A medium of exchange:Money is used as a medium of exchange because it is an efficient way to allocate re-
sources. Economies have goods and services that need to be allocated to people. The best way to do this is to es-
tablish a currency because it establishes structure. If we didn’t have currencies, people would likely be bartering
(or stealing!) their way through life. Economics as we know it would take on a different role, one that involved a
survival of the physical fittest.
■ A unit of account:Money helps us understand relative values of goods and services. We can gauge how much a
day of work is worth in terms of goods and services. The value of a diamond ring can be distinguished from the
value of shoes. Money allows us to determine how valuable labor and wages are relative to goods and services.
■ A store of value:We can exchange money for a good or service at any time without worrying about our money
expiring. Our currency doesn’t rot, wither, or melt away. It can be kept for long periods of time without a loss of
exterior value. However, the value money holds in terms of what goods and services it can purchase varies as a
result of the fluctuating forces of supply and demand.