CHAPTER 1 : THE NOTION OF MONEY

The first chapter of monetary economics will allow students to be able to describe
the definition of “money”; distinguish among the three primary functions of
money; understand the evolvement of payments system; understand how money
is measurement.
For students to better understand the effects of money on the economy, they must
understand exactly what money is. The first chapter of the course focuses on
precise definitions of money and its functions; it enables to understand why and
how money promotes economic efficiency; this is done by tracing how the forms
of money have evolved over time; this chapter also considers the measures of
money.
I- DEFINITION OF MONEY
Considering everyday conversations on money, this word can mean many things.
The definition of money provided by economists differs from conventional usage.
Economists define money as anything that is generally accepted in payment for
goods or services or in the repayment of debts. Currency is one type of money. It
consists of CFAF bills and coins. When most people talk about money, they are
talking about currency (paper money and coins).
Defining money merely as currency is too narrow for economists. Given that
cheques are also accepted as payment for purchases, chequing account deposits
represent money as well. An even broader definition of money is often needed
because other items such as savings deposits can function as money. Hence,
there is no single, precise definition of money or the money supply, even for
economists.
The word money is commonly used synonymously with wealth. And this
represents a broad definition of money. Economists make a distinction between
money in the form of currency, demand deposits, and other items that are used to
make purchases, and wealth, the total collection of pieces of property that serve
to store value. Wealth includes not only money but also other assets such as
bonds1, common stocks (shares), art, land, furniture, cars, houses, etc.
People also use the word money to describe what economists call income.
Income is a flow of earnings per unit of time. Money, by contrast, is a stock: it is
a certain amount at a given point in time. If someone tells you that he has an
income of CFAF 100000, you cannot tell whether he earned a lot or a little without

1
Bond is a certificate issued by a government or a public company promising to repay borrowed money at a
fixed rate of interest at a specified time.

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knowing whether this CFAF 100000 is earned per year, per month, or even per
day. But if someone tells you that she has CFAF 100000 in her pocket, you know
exactly how much this is.
In the present course, money refers to anything that is generally accepted in
payment for goods and services or in the repayment of debts. Kindly note that
money, as considered in this course, is distinct from income and wealth.
We now consider the functions performed by money in the economy.
II- FUNCTIONS OF MONEY
Whatever its forms, money has three primary functions in any economy. It is a
medium of exchange, a unit of account, and a store of value. However, its function
as a medium of exchange is what distinguishes money from other assets such as
stocks, bonds, and houses.
II.1 Money as a medium of exchange
Money serves as a medium of exchange in our economy. That is, money in the
form of currency or cheques is used to pay for goods and services. This is
observed in almost all market transactions. The use of money as a medium of
exchange promotes economic efficiency. This is explained by the fact that money
eliminates much of the time spent in exchanging goods and services as compared
to a barter economy. In a barter economy, there is no money and goods and
services are exchanged directly for other goods and services. In that economy, the
time spent trying to exchange goods or services is called a transaction cost.
In a barter economy, transaction costs are high because people have to satisfy a
“double coincidence of wants”, i.e., they have to find someone who has a good
or service they want and who also wants the good or service they have to offer.
With money, the problem of the double coincidence of wants (which is time-
consuming) is avoided and this allows economic agents to save a lot of time,
which they may spend in alternatives uses or alternative economic activities.
Money therefore promotes economic efficiency by eliminating much of the time
spent exchanging goods and services. It also promotes efficiency by allowing
people to specialize in what they do best. Money is therefore essential in an
economy. It acts as a lubricant that allows the economy to run more smoothly by
lowering transaction costs, thereby encouraging specialization and the division
of labour.

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The need for money is so strong that almost every society beyond the most
primitive invents it. For a commodity to function effectively as money, it has
to meet several criteria:
(1) money must be easily standardized, making it simple to ascertain its value;
(2) money must be widely accepted;
(3) money must be divisible so that it is easy to make change;
(4) money must be easy to carry;
(5) money must not deteriorate quickly.
Forms of money that have satisfied these criteria have taken many forms
throughout human history. The diversity of forms of money that have been
developed over the years is as much a testament to the inventiveness of the human
race as the development of tools and language.
II.2 Money as a unit of account
Money provides a unit of account. In other words, money is used to measure
value in the economy. People measure the value of goods and services in terms
of money, just as one measures the performance of a student in terms of marks or
the size of a household in terms the number of children. Money as a unit of
account is a very important function.
In a barter economy, the formula for the number of prices needed by economic
agents when there are N goods is the same formula that captures the number of
pairs when there are N items. It is:
𝑵(𝑵 − 𝟏)
𝟐
For example, if there are 4 goods in a barter economy, economic agents must have
𝟒(𝟒 − 𝟏)
= 𝟔 𝒅𝒊𝒇𝒇𝒆𝒓𝒆𝒏𝒕 𝒑𝒓𝒊𝒄𝒆𝒔
𝟐
The solution to the problem is to introduce money into the economy and have all
prices quoted in terms of units of that money, e.g., CFAF. Using money as a unit
of account reduces transaction costs in an economy by reducing the number of
prices that need to be considered.
II.3 Money as a store of value
Acting as a store of value, money is seen as a repository of purchasing power
over time. A store of value is used to save purchasing power from the time income

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is received until the time it is spent. This function of money is useful because most
economic agents do not want to spend their income immediately upon receiving;
this can be done in the future.
Kindly note that money is not unique as a store of value; any asset, whether
money, stocks, bonds, land, houses, art, or jewellery, can be used to store wealth.
Many such assets have advantages over money as a store of value: they often pay
the owner a higher interest rate than money and experience price appreciation. If
these assets are a more desirable store of value than money, why do people hold
money at all?
The answer to this question relates to the important economic concept of liquidity,
the relative ease and speed with which an asset can be converted into a medium
of exchange. Liquidity is highly desirable. Money is the most liquid asset of all
because it is the medium of exchange; it does not have to be converted into
anything else in order to make purchases. Other assets involve transaction costs
when they are converted into money. The fact that money is the most liquid asset,
then, explains why people are willing to hold it even if it is not the most attractive
store of value.
How good a store of value money is, depends on the price level, because its value
is fixed in terms of the price level. A doubling of all prices, for example, means
that the value of money has dropped by half; conversely, a halving of all prices
means that the value of money has doubled. During a period of high inflation,
when the price level is increasing rapidly, money loses value rapidly, and people
will be more reluctant to hold their wealth in this form.
III. PAYMENTS SYSTEM: ITS EVOLUTION
The payments system is the method of conducting transactions in the economy.
It enables the understanding of the functions and forms of money over time. At
one-point, precious metals such as gold were used as the principal means of
payment and were the main form of money. Later, paper assets such as cheques
and currency began to be used in the payments system and viewed as money.
III.1 Commodity Money
To obtain perspective on where the payments system is heading, it is worth
exploring how it has evolved. For any object to function as money, it must be
universally acceptable; everyone must be willing to take it in payment for goods
and services. An object that clearly has value to everyone is a likely candidate to
serve as money, and a natural choice is a precious metal such as gold or silver.
Money made up of precious metals or another valuable commodity is called
commodity money. The problem with a payments system based exclusively on
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precious metals is that such a form of money is very heavy and is hard to transport
from one place to another.
III.2 Fiat Money
After commodity money, the payments system evolved towards paper currency.
This is defined as pieces of paper that function as a medium of exchange. Initially,
paper currency embodied a promise that it was convertible into coins or into a
quantity of precious metal. However, currency has evolved into fiat money. Fiat
money is paper currency decreed by governments as legal tender (i.e., legally, it
must be accepted as payment for debts) but not convertible into coins or precious
metal. Paper currency has the advantage of being much lighter than coins or
precious metal. However, paper currency can be accepted as a medium of
exchange only if there is some trust in the authorities who issue it and printing
has reached a sufficiently advanced stage that counterfeiting is extremely
difficult. Because paper currency has evolved into a legal arrangement, countries
can change the currency that they use at will.
Major drawbacks of paper currency and coins are that they are easily stolen and
can be expensive to transport because of their bulk if there are large amounts. To
combat this problem, another step in the evolution of the payments system
occurred with the development of modern banking: the invention of cheques.
III.3 Cheques
A cheque is an instrument from you to your bank used to transfer money from
your account to someone else’s account when she deposits the cheque. Cheques
allow transactions to take place without the need to carry around large amounts
of currency. The introduction of cheques was a major innovation that improved
the efficiency of the payments system. Frequently, payments made back and forth
cancel each other; without cheques, this would involve the movement of a lot of
currency. With cheques, payments that cancel each other can be settled by
cancelling the cheques, and no currency need be moved. The use of cheques thus
reduces the transportation costs associated with the payments system and
improves economic efficiency. Another advantage of cheques is that they can be
written for any amount up to the balance in the account, making transactions for
large amounts much easier. Cheques are advantageous in that loss from theft is
greatly reduced, and they provide convenient receipts for purchases.
There are, however, two problems with a payments system based on cheques.
First, it takes time to get cheques from one place to another, a particularly serious
problem if you are paying someone in a different location who needs to be paid
quickly. In addition, for economic agents having a chequing account, it usually

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takes several business days before a bank will allow you to make use of the funds
from a cheque you have deposited. If your need for cash is urgent, this feature of
paying by cheque can be frustrating. Second, all the paper shuffling required to
process cheques is costly.

III.4 Electronic payment

Phones and computers as well as the spread of the Internet facilitate the payment
of bills electronically. Banks provide websites that allow economic agents to log
on, make a few clicks, and thereby transmit their payment electronically. This
requires little effort. Electronic payment systems provided by banks now even
spare economic agents the step of logging on to pay bills. Instead, recurring bills
can be automatically deducted from their bank accounts.
III.5 E-money
Electronic payment technology can not only substitute for cheques, but can
substitute for cash, as well, in the form of electronic money (or e-money), money
that exists only in electronic form. Whatever the advantages of e-money, you it is
not possible to quickly move to a cashless society in which all payments are made
electronically.
IV. MEASURING MONEY
Monetary Aggregates enables the measurement of money. In fact, the definition
of money as anything that is generally accepted in payment for goods and services
implies that money is defined by people’s behaviour. What makes an asset money
is that people believe it will be accepted by others when making payment. As we
have seen, many different assets have performed this role over the centuries,
ranging from gold to paper currency to chequing accounts. For that reason, this
behavioural definition does not clarify what assets in the economy should be
considered money. To measure money, a precise definition in terms of assets to
be included is needed. This is done through monetary aggregates in the CEMAC
sub-region.