What Is Money?

Nick Rowe says we should not think of money as a store of wealth:

Money is what money does. There are two functions of money that define what is and what is not used as money: medium of exchange; and medium of account. That’s it… We need to start worrying a lot more about how money works as a medium of exchange. We need to understand a lot better than we do how money works as a coordinating device in a decentralised economy. And we need to understand a lot better than we do how money can sometimes fail as a coordinating device. Because, outside a very simple economy, people can’t barter their way back to full employment if the monetary exchange system fails.

We need to stop thinking of money as a store of wealth, just like all the others. And let’s start by changing the textbook definition of money, by deleting that bit about money being a store of wealth.

I agree, but would add that we also need to start thinking about money at all levels of transactions. Most textbooks and many economists think of money assets at only the retail level (i.e. the M2 money supply). This crisis has taught us that institutional money assets–those assets like treasuries, commercial paper, and repos that facilitate transactions in the financial system–matter too. The bank run on the shadow banking system was a bank run using institutional money assets. If we really want to understand money and its implications for the economy we need to be thinking about these money assets too. Thanks to Gary Gorton, David Aldonfatto, and Stephen Williamson I have come to better appreciate this point. And thanks to this perspective I have come to see the demand for safe assets and budget deficits in a different light.

This post originally appeared at Macro and Other Market Musings and is posted with permission.

2 Responses to "What Is Money?"

  1. Benedict@Large   February 27, 2012 at 11:18 pm

    The store of value function is what creates banking, capital accumulation, and indeed capitalism itself.