ICAI Notes 8.1 - Money | Business Economics for CA Foundation PDF Download

Learning Objectives

• know the meaning of money.
• understand the functions of money.

Meaning of Money

Money is an important and indispensable element of modern civilization. In ordinary usage, what we use to pay for things is called money. To a layman, thus, in India, the rupee is the money, in England the pound is the money while in America the dollar is the money. But to an economist, these represent merely different units of money. Then how do we define money?

Definition of Money

• It is very difficult to define money in exact sense. This is because, there are various categories of assets which possess the attributes of money. 
• Many things such as clay, cowry shells, tortoise shells, cattle, slaves, rice, wool, salt, porcelain, stone, gold, iron, brass, silver, paper and leather etc. have been used as money. 
• Traditionally, money has been defined on the basis of its general acceptability and its functional aspects.
• Thus, any thing which performed the following three functions
  (i) served as medium of exchange
  (ii) served as a common measure of value and
  (iii) served as a store of values, was termed as money.
• To modern economists or empiricists, however, the crucial function of money is that it serves as a store of value. It thus includes, not only currencies and demand deposits of banks, but also includes a host of financial assets such as bonds, government securities, time deposits with banks and equity shares which serve as a store of value. 
• Some economists categorise these financial assets as near money, distinct from pure money which refers to cash and chequable deposits with commercial banks. The empiricists argue that whether a financial asset should be included in money should be decided on the basis of empirical investigation of the financial asset. To them, money is what money does.
• While clustering financial assets as money they have laid down certain criteria :
  (i) stability of the demand function,
  (ii) high degree of substitutability, and
  (iii) feasibility of measuring statistical variations in real economic factors influenced by the monetary policy.

Functions of Money

In a static sense, money serves :

1. As a medium of exchange : The fundamental role of money in an economic system is to serve as a medium of exchange or as a means of payment.
2. As a unit of account : Money is a common measure or common denominator of value. The value in exchange of all goods and services can be expressed in terms of money. In fact, it acts as a means of calculating the relative prices of goods and services.
3. As standard of deferred payments : Money is a unit in terms of which debts and future transactions can be settled. Thus loans are made and future contracts are settled in terms of money. 
4. As store of value : Money being a permanent abode of purchasing power holds command over goods and services all the times-present and future. Money is a convenient means of keeping any income which is surplus to immediate spending needs and it can be exchanged for the required goods and services at any time. Thus it acts as a store of value. In dynamic sense, money serves the following functions :
5. Directs economic trends : Money directs idle resources into productive channels and there by affects output, employment, consumption and consequently economic welfare of the community at large.
6. As encouragement to division of labour: In a money economy, different people tend to specialise in the different goods and through the marketing process, these goods are bought and sold for the satisfaction of multiple wants. In this way, occupational specialisation and division of labour are encouraged by the use of money.
7. Smoothens transformation of savings into investments: In a modern economy, savings and investments are done by two different sets of people - households and firms. Households save and firms invest. Households can lend their savings to firms. The mobilisation of savings can be done through the working of various financial institutions such as banks. Money so borrowed by the investors when used for buying raw materials, labour, factory plant etc. becomes an investment. Saved money thus can be channelised into any productive investment.

Money Stock in India

• In 1979 the RBI classified money stock in India in the following four categories.
• M₁ = Currency with the public i.e., coins and currency notes + Demand deposits of the public known as narrow money.
• M₂ = M₁ + Post office saving deposits.
• M₃ = M₁ + Time deposits of the pubic with banks called broad money.
• M₄ = M₃ + Total post office deposits.
• The basic distinction between narrow money (M₁) and broad money (M₃) is in the treatment of time deposits with banks.
  Narrow money excludes time deposits of the public with the banking system while broad money includes it. Not much significance is attached to M₂ and M₄ by the RBI. This classification was in vogue till recently. 
• The RBI working group has now redefined its parameters for measuring money supply:
  M₁ = Currency + Demand deposits + Other deposits with RBI.
  M₂ = M₁ + Time liabilities portion of saving deposits with banks + Certificates of deposits issued by banks + Term deposits maturing within a year excluding FCNR (B) Deposits.
  M₃ = M₂ + Term deposits with banks with maturity over one year + Call/term borrowings of the banking system. M₄ has been excluded from the scheme of monetary aggregates.

Summary

Money is the life line of modern civilisations. Traditionally, money served as, medium of exchange, unit of account, store value of money and standard of deferred payment. But in the modern economies, it carries out certain dynamic functions such as catalyst in division of labour, director of economic trends and motivator in transformation of savings into investments. Money stock in India is divided into narrow money and broad money. Narrow money excludes time deposits but broad money includes it.