The classical economists were of the view that money was discovered to remove the defects of barter. The important functions of money for them were to serve as a medium of exchange and standard of material. They examined in detail the characteristics of a good money material and the forces which operate in determining the value of money. The classical economists were of the view that the volume of output, the quantity and quality of the goods to be consumed, the volume of exchange, distribution of wealth, rate of saving and investment, etc., are not to be influenced by the use of money. They, therefore, regarded money as neutral. To quote Adam Smith “The gold and silver money which circulates in any one country may very properly be compared to a highway which while it circulates and carries to market all the grass and corn of the country, produces not a single pile of either.” In the words of Jevon, “Accustomed from our earliest years to the use of money, we are unconscious of the inestimable benefit which it confers upon us and only when we recur to oblige their different states of society we can realize the difficulties which arise in its absence.
Robertson in his book Principles of Money’ states “Money enables man as consumer to generalize his purchasing power and make his claims on society in the form which suits him most.” The modem economists fully recognize the economic role of money as a medium of exchange and standard of value. They regard it as an economic catalyst. They emphasize that in a capitalistic economy, money exercises a decisive influence on the volume of production, distribution of wealth and income, direction and volume of exchange and on the rate of saving and investment in the country. We, here, discuss in brief the significance of money in a capitalistic and centrally controlled economy. (a) Role of Money in a Capitalistic Economy: Money is the sovereign queen of all delights. For her the teacher teaches, the lawyer pleads, the dancer dances, the soldier fights. In a capitalistic economy, money is the pivot around which all economic activities cluster.
Money is an indicator as well as a surveyor of wealth. The importance of money can be judged from the powerful influence which it exercises on the (1) Volume of production; (2) Direction of production; (3) Pattern of consumption; (4) Method of distribution; (5) Direction and volume of exchange; and (6) Rate of saving and mi investment in the country. Production Decisions. Production has been greatly facilitated by the introduction of money. Money makes possible the accumulation of wealth in those hands which are Able to organize the production. The captain of the industry hires the various factors ‘ of production in order to meet the future demand for goods and services and pays them in terms of money If the reward was to be paid in commodity, then the exchange of goods would have been very limited and so the production on a small scale Production without the use of money cannot be organized on a large scale and run efficiently and economically.
The decision of what, where, when and how much to produce are all guided by the amount of money offered in exchange of goods and service. The cost of production is also estimated in terms of money. The profit or loss which is the difference between the sales proceeds and the total money cost is also expressed in terms of money. With the introduction of money. The consumption can be easily postponed and the assets can be stored for use to a future date. Exchange Transactions: In a moneyless economy, exchange of goods was a very inconvenient process. People used to face the difficulties of double coincidence of wants. There was also no common measure of value. The use of money has successfully removed the awkwardness of barter. Money, by acting as a medium of exchange, has greatly stimulated the exchange of goods.
It splits up exchange process into two parts, sale and purchase and thus facilitates flow of goods and services from producers to consumers. Distribution of National Dividend: The four factors of production, combining %y together, produce a net aggregate of commodities every year. The share of each factor of production i.e., rent of land, wages of labor, interest on capital and profit to entrepreneur is paid in terms of money, if the share of each factor of production was to be paid by dividing joint products, it would have caused much inconvenience to each distributor. Imagine, a cloth producer paying the share of each factor of production in term of Cloth. As money is generally acceptable as a medium of “exchange and at the same time acts as a measure and a store of value, therefore, the distribution of national dividend through the medium of money greatly facilitates the processes of distribution. In the words of Jevon “Money subdivides and distributes properly and lubricates the activities of exchange”.
Money in the Field of Public Finance: Money renders a very valuable service in the field of public finance. Public Finance in recent times aims at increasing the rate of economic activities and reducing inequalities of income. It also acts as an instrument of economic and social justice in a country. Money helps the state in the achievement of these objectives. The government can easily raise revenue through the medium of money and can spend it for the betterment of the people. Money in the Sphere of Banking: We know it very well that money serves as standard of deferred payments. The general confidence in the purchasing power of money makes it the chief farm of credit.
The debtor can safely borrow money for consumption or for production purposes. This has led to the building up of a gigantic superstructure of banking and credit system. Attainment of High Level of Production and Employment: The introduction of money in the economy has facilitated exchange. It has led to high degree of specialization and interdependence of economic units; If the money is properly managed, it ensures rising level of productions employment and real income in the Country. In case, the delicate instruments is not properly handled, it leads to decline in the prices, output and job opportunities. We, thus, find that the behavior of employment, rate of output, level of price and distribution of national income are all directly related to the monetary forces.
Money as an Aid to Progress. Functions And Kinds Of Money.
Four Functions; Subsidiary Coin; Comparative Value of Silver And Gold; Demonetization Of Silver, Etc. Money has four functions, viz.: 1. A medium of exchange. 2. A measure of value. 3. A standard of value for future payments. 4. A store of value. Money is as essential to the interchange of commodities as language is to the interchange of ideas. Without some common medium of exchange it would be absolutely impossible to carry on the manufactures and commerce of the country. The rude system of bartering one product for another as the parties may each need, is only adapted to a low civilization where wants are few and simple. The history of civilization and progress is concurrent with the history of money. The breaking up of feudalism in the middle ages, and the growth of commerce, was due largely to the introduction and use of money, by which the vassals were able to pay their rent in money instead of services. In order to effect exchanges of commodities there must be an equality of values, and in order to establish this equality of values a measure of value is necessary.
A measure of value in the exchange of commodities is as necessary as the yard stick or pound weight in measuring quantities. It is useless to convert all things into terms of money as a medium of exchange unless this is done at certain rates, for without fixing the rate or measure of value between commodities no exchange is possible. In this country the standard unit of value is the gold dollar consisting of a certain amount of gold and alloy fixed by act of Congress, and all values are measured in dollars or parts of a dollar. Although the gold dollar is the standard, it is not necessary that all payments be made in gold dollars. We use silver, nickel, copper and paper as actual mediums of exchange, but of course they are all founded upon the gold dollar as the standard. A farmer agrees to pay a fixed proportion of his produce as rent, say one-third of his corn, but when the time arrives for payment he may, by agreement with the landlord, pay in gold, silver, paper, wheat, cattle or any other commodity, the quantity being measured, of course, by the value in gold dollars.
In other words, the medium of exchange or payment may be different from the measure of value. We may measure in one thing, and pay in another. The medium of exchange would be useless unless measured in terms of the standard, and the measure would be useless without some medium of exchange by which the transaction could be carried out. A person having an article for sale desires to know what its value is, compared with other articles; that is, to have it measured by a common, recognized standard of value, but he also desires that, when he is ready to sell the article, there shall be a medium of exchange by which, he can dispose of all, or as much of it as he desires, without having to resort to the primitive system of barter. Since many contracts involve the payment of money at some distant future time it is essential that money should possess stability or uniformity of value. Suppose that in the case of a lease for many years the tenant agrees to pay a fixed rental in gold, and during the term of the lease the production of gold at the mines should be greatly increased – doubled, say.
The result would be that the value of gold would diminish and its purchasing power would be reduced. Prices of other commodities would rise. A gold dollar would not buy as much of anything as it did before. Now the tenant would be able to sell his goods at higher prices but his rent would remain the same in dollars. In this case the landlord would suffer a disadvantage. Suppose, on the contrary, that the mines failed to yield the customary amount of gold for a series of years and gold became scarce. Its scarcity would increase its value. Then a dollar of gold would have greater purchasing power and prices of other commodities would fall. The rent under this long term lease would remain the same, however, and the tenant must now pay his rent in dearer money. The landlord in this case would reap an advantage, as he would be getting a higher rent – the same rent nominally, but of greater purchasing power. .
The whole fabric of the business world is made up of an endless series of contracts, many of them extending into years of futurity for their fulfillment, such as contracts for future delivery of goods, leases of houses and lands, hiring of services for a term of years, the settlement of estates of inheritance to be made upon the maturity of minors, or the payment of pensions, annuities or life insurance, and it is important in all such undertakings that the money which is our standard of value now, and the basis on which the contract is made, shall continue uniform and finally possess the same value or purchasing power at the end of the period of time for which the contract runs. Were our standard of value such a commodity as wheat, an abundant crop would diminish its purchasing power and correspondingly raise prices of other commodities and vice versa to the serious injury of one class and the benefit of another.
Fortunately for the commodity gold, which all of the most advanced nations have chosen as their standard of value, its production is remarkably uniform. The earth yields a constant and never-failing supply of the precious metal, not of such abundance as to affect its value or relieve man of the necessity of giving back value in labor for value in gold received, yet in sufficient measure to repay the effort in seeking and mining it. It costs substantially a dollar in labor generally to get a dollar’s worth of gold out of the earth and coin it into money. Thus gold is especially adapted to perform this function of the money standard of value for future payments. Money may be said to perform a fourth function – that of a convenient means of storing value. When acting as a medium of exchange it circulates back and forth in the same locality, and may sometimes return to the same person, but at times a person desires to condense his wealth into small space and perhaps transport it to a distant country, or hoard it away for a time. Money in the form of the precious metals affords a convenient means of doing this.
It is true that other commodities of small bulk, imperishable quality, and great value, such as diamonds or other precious stones, might be used for hoarding, and sometimes are, but their value is not affixed or stamped thereon, and their future value may not be uniform or stable. Gold coin is an exceptionally convenient means of hoarding or transporting money, and the facility with which it can be hoarded has a manifest tendency to beget economy and encourage accumulation, especially among the industrial classes. The large number of savings banks throughout the United States, with their enormous total of deposits and millions of depositors, is largely the effect of frugality and saving caused by the facility which the precious metals afford for hoarding or storing value. Subsidiary coin or “token money” may be defined as coin, the nominal value of which as money is greater than its value as metal, even making allowance for the cost of coinage.
When the government in 1834 changed the legal rate of silver to gold from 15 to 1 to the ratio of 16 to 1, making sixteen grains of pure silver equal to one of pure gold, the silver dollar then became of greater value than the gold dollar by 21/4 cents. Naturally people preferred to pay their debts in the cheaper metal, gold, and silver ceased to circulate. People who had silver on hand either converted it to other uses or sold it to brokers who melted it into bullion and exported it to other countries where its full value could be realized. We were then without silver for fractional currency, except worn halves, quarters and dimes which had lost 2 1/4 per cent, of their value by abrasion, and hence were equal in value to so many cents in gold. Then the increased supply of gold from California in 1850 caused a still further advance of 1 3/4 per cent, in the price of silver, driving still more of the white coin out of the county, and causing the remaining coins to be still lighter and smoother.
To remedy this difficulty and supply the country with silver for fractions of a dollar, Congress in 1853 passed a law providing for the coinage of new silver half dollars, quarters, dimes and half dimes about seven per cent lighter than the former ones. There being no inducement to melt these coins into bullion or export them, they circulated at par with gold (except during the suspension of specie payments), although their metallic value was considerably less than their nominal value as silver. This was the beginning of silver as subsidiary coin in the United States. The price of silver continued to fall, as compared with gold, until 1874, but during all of this time no silver dollars were in circulation, silver being worth more than gold. In 1873 Congress passed an act demonetizing silver. The metal in the silver dollar at the time of the passage of the demonetization act was worth two cents more than a gold dollar, but the price of silver has since continued to decline until it has become worth less than half its nominal value*.
It now circulates freely as subsidiary coin, since the amount of silver coined and in circulation is limited and it is receivable for all.public dues. Receiving it for public dues is one way of redeeming the coin. Besides silver we have subsidiary coin in the form of fractional currency, consisting of copper and nickel. These are redeemable by the government in gold when presented in sums of twenty dollars or more. Paper money consists of printed promises to pay a given sum of money to the holder on demand. It is the government’s promise to pay. It is not money, in reality, but represents money, and circulates instead of the actual coin. We call it money because it circulates from hand to hand and performs some of the functions of money, and because it will purchase our wants the same as money.
It is redeemable or convertible into actual money on demand, and is issued either directly by the government or by banks under the authority of the government. There are several important advantages in favor of the use of paper money. It is lighter than coin and hence more convenient to carry in the pocket. Coin loses by abrasion, but paper can be readily replaced with new. Paper money can be sent through the mails or transported by express much more easily than coin. •Congress passed an act in February, 1878, remonetizing silver, but notwithstanding this its value has continued to fall, and it only circulates at its nominal value because the Government receives it at the equivalent of gold at the custom house and tax office. Paper money may be divided into two kinds, distinguished on account of the origin of each, viz., Fiat Money and Representa-tive money. These may be further subdivided as follows:
Fiat money consists of promises to pay by the government direct, or by banks under authority and control of the government, founded upon the faith of the people in the stability and credit of the government. Such bills are issued under a special law which limits the quantity, pledges the government to redeem them in gold on demand, and provides for a sufficient reserve fund of gold coin, to be kept on hand to redeem the bills in circulation.
Definition of ‘Monetary Theory’
A set of ideas about how monetary policy should be conducted within an economy. Monetary theory suggests that different monetary policies can benefit nations depending on their unique set of resources and limitations. It is based on core ideas about how factors like the size of the money supply, price levels and benchmark interest rates affect the economy. Economists and central banking authorities are typically those most involved with creating and executing monetary policy. Investopedia explains ‘Monetary Theory’
In many developing economies, monetary theory is controlled by the central government, which may also be conducting most of the monetary policy decisions. In the U.S., the Federal Reserve Board sets monetary policy without government intervention. The Federal Reserve operates on a monetary theory that focuses on maintaining stable prices (low inflation), promoting full employment and achieving steady growth in gross domestic product (GDP). The idea is that markets function best when the economy follows a smooth course, with stable prices and adequate access to capital for corporations and individuals.