Money - Characteristics and Functions (Financial Economics)

According to the Bank of England, in a modern economy, money is a type of IOU, but one that is special because everyone in the economy trusts that it will be accepted by other people in exchange for goods and services.

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Money serves several key functions in an economy. These functions are essential to the smooth operation of trade, investment, and economic development. The key functions of money are:

1. Medium of Exchange: Money acts as an intermediary in the exchange of goods and services. It eliminates the inefficiencies of a barter system, where finding a mutual coincidence of wants (i.e., someone who has what you need and needs what you have) can be difficult. As a universally accepted means of payment, money facilitates trade by making transactions simpler and quicker.
2. Unit of Account: Money provides a common measure for the value of goods and services. It allows individuals, businesses, and governments to compare prices, assess costs, and keep records. In this way, it simplifies decision-making and economic planning. Prices expressed in a common currency make it easier to understand relative value and perform economic calculations.
3. Store of Value: Money allows people to store wealth and value over time. This function is important because it provides a way to save purchasing power for future use. Unlike perishable goods or non-liquid assets, money is generally durable and can be held without significant loss of value, assuming a stable currency and low inflation.
4. Standard of Deferred Payment: Money facilitates agreements on future payments, such as loans or contracts. It provides a standardized way to settle debts or future transactions because both parties know the value of the currency being used in the agreement. This function helps with credit and lending, as well as planning for future obligations.

Together, these functions make money an indispensable tool for economic exchange and financial systems.