Role of money
AQA also says:
Spec content: Functions of money; Characteristics of money; Role of commercial banks; Role of central banks.
Students should be able to understand: the functions of money; the characteristics of money; the role of commercial banks; the role of central banks.
Functions of Money
Money performs four key functions in any economy:
- Medium of exchange — money is universally accepted in payment for goods and services, eliminating the need for barter (the "double coincidence of wants" problem). This is money's primary function.
- Store of value — money can be saved and used in the future. It retains purchasing power over time (though inflation erodes it). This allows people to save and plan for the future.
- Unit of account — money provides a common measure for expressing the value of goods and services, enabling price comparison and economic calculation.
- Standard of deferred payment — money allows transactions to be settled in the future (credit, loans, contracts). Debts can be expressed in monetary terms and repaid later.
Characteristics of Good Money
For money to function effectively it should be:
- Acceptable — widely accepted by buyers and sellers
- Scarce — limited supply maintains its value
- Durable — does not deteriorate quickly
- Portable — easy to carry and transfer
- Divisible — can be divided into smaller units for different transaction sizes
- Homogeneous — all units of the same denomination are identical
Role of Commercial Banks
Commercial banks (Barclays, HSBC, Lloyds, NatWest etc.) are private profit-seeking institutions that:
- Accept deposits from savers, paying interest
- Lend money to borrowers (individuals, businesses) at higher interest rates, earning a profit from the spread
- Provide payment services (current accounts, debit cards, transfers)
- Create credit — when banks lend, they create new deposits in the financial system, effectively creating money
- Provide financial advice and investment products
Role of the Central Bank (Bank of England)
- Banker to the government — manages the government's accounts and national debt
- Banker to the banks — commercial banks hold accounts at the Bank of England; it acts as lender of last resort in financial crises
- Issue notes and coins — sole issuer of Bank of England banknotes in England and Wales
- Monetary policy — sets the base rate (MPC) to control inflation
- Financial stability — supervises banks and financial institutions (through the Prudential Regulation Authority) to prevent systemic risk
- Foreign exchange reserves — manages the UK's gold and foreign currency reserves
Key Takeaways
- Four functions of money: medium of exchange, store of value, unit of account, standard of deferred payment.
- Good money is: acceptable, scarce, durable, portable, divisible, homogeneous.
- Commercial banks: accept deposits, make loans, provide payments, create credit.
- Bank of England: monetary policy, lender of last resort, note issuance, financial stability, government banker.