What is meant by 'money' in a modern economy - Essay Example

TOPIC:What is meant by 'money' in a modern economy Critically evaluate the view that the Bank of England has full control over the quantity of money in circulation. INTRODUCTION: The issue of money is an issue that has been established right from the existence of man. It is an issue that has been for the ages - right from ancient days to the present modern society. Humanity and its components have gone through different stages of economic development and advancement, and have grown from a simple comprehendible society to our complex modern one through the use of money. The effect that money has brought about in the economic sector can not be undermined. Alla Stephun, while writing on the philosophy of money says "Money is a reality, a permanent feature of our everyday lives. It gives our lives a particular rhythm, a particular charm, a particular perception of the world and our place in it." This buttresses the point that money has really affected and effected humanity. There are situations where we think of what money is in modern society. In attempt to answer some of these pertinent questions, a number of topics will have to be discussed. These essay therefore examines the issue that has to do with money in the modern economy, explaining what credit creation is. Particular attention will be devoted to the role of the Bank of England as a full controller of the quantity of money in circulation in the UK economy. WHAT MONEY Before delving into the in-depth issue of how money and modern economy relates, it will definitely not be out of place to ask oneself "what money is" Money can be defined in a number of different ways - from the simple manner to the complex .The way it is defined ,depends to an extent on the situation and circumstances surrounding the situation. But whatever way money is to be defined, it all points to one direction - it is a medium of exchange. According the website, http://en.wikipedia.org/wiki/Money money is any good or token used by a society as a medium of exchange, store of value and unit of account. It is a legal tender, and wealth is measured by the amount of money possessed. Money does not necessary need to be in cash - which is money is form of bills(notes) or coins, it can also be form of assets - items that have economic value. So to this effect, we can also refer to money as being any items that carries out the function of money. CHARATERISTICS OF MONEY: Money, just as any other entity has certain characteristics that are associated with it. Some of the very obvious characteristics of money will be briefly talked about here. These are: 1. Durability: This refers to money being able to maintain its shape or form over a period of time. For money to be able to perform certain of its functions- like being a medium of exchange or a store of value, it has to posses the characteristics of durability. 2. Portability: This has to do with the easy movement between different locations that money has to undergo when there is the need, particular for exchange purposes. 3. Divisibility: Money has to be capable of being easily divided into smaller fractions, when exchange for good s or services of varying values are to be made. For any medium of exchange to be efficient, it has to have that capacity of serving in that capacity at varying values. FUNCTION OF MONEY: The single reason that money serves as a medium of exchange, makes us all to know that it has some usefulness. Money is desirable, though there are some individuals that are of the view that the possession of too much of money by a single entity is bad. Some of the characteristics of money are: 1. Medium of Exchange: Money serves as a medium of exchange, good and services are exchanged for money. An older manner where trading was done was by barter. Money has made transactions in modern times to be easier. 2. Unit of Account: This means that money serves as the benchmark for determining the worth of good s and services in a modern economy. It functions as the measuring unit of value or prices. 3. Store of Value: Money serves as a store for values of perishables, depreciating, and consuming goods or services. Satisfaction derived from sold goods or services can be stored or preserved with money. PROBLEMS OF MONEY MEASUREMENT: Money measurement has to do with quantifying of the value of money. This has been a problem because the value of money differs with location and time. MONEY IN THE MODERN ECONOMY: In the modern economy, money takes a number of forms. Apart from existing as cash, it can equally exist in form of substitutes, in that when used, financial transactions can be recorded. Examples of money substitutes are cheques, credit cards, debit cards etc. CREDIT CREATION: Credit creation involves the creation of money by providing credits. It can also be said to be the provision or making of loans. When loan is provided as a means of money creation, it is normally subject to regulation, as the lender do have limit to the amount of loan provided in relative to the asset the borrower makes available, so as not to be at a high risk of bankruptcy. It therefore means that the amount of assets puts a limit to credit creation. Banks can create credit/money by providing loans that can lead to additional deposits. In United Kingdom, the Bank of England tries to control the amount of credit created, keeping it below a level that will lead to an increase in money supply. This singular act is to check and curtail inflation. THE BANK OF ENGLAND: The Bank of England is the central bank of the United Kingdom. The bank was founded in 1694, and after going through different phases, became operationally independent on May 1997.The main duty of the bank is to maintain price stability, and subject to that, to support the economic policy of Her Majesty's Government (Bank of England Act 1998). Among other duties that the bank has, the two main duties of the bank are: 1. Financial control - this has to do with keeping the financial system of UK in check. This is achieved through the use of the bank's marketing intelligence and monitoring functions. 2. Monetary control - this has to do with the stability in price and the confidence the currency of a nation gives. Inflation target of the Government of United Kingdom defines stable prices and the Bank of England strives to meet. This is done through the decisions on interest rates taken by the Monetary Policy Committee (MPC) of the Bank. TECHNIQUES OF MONEY CONTROL USED BY THE BANK: The Monetary Policy Committee (MPC) of the bank meets on monthly basis to determine the interest rates in United Kingdom. The committee has among the nine members, the Governor of the bank as its member. Five of the members are internal members while four are external members appointed by the Chancellor of Exchequer .MPC study the UK economy as well as the world economy, which is normally provided by the Bank's home and regional economic representatives during their monthly meetings. The main agenda of the meeting being price stability. Decisions are being made by way of voting on the interest rates which is being defined by the government's inflation target as set in the year's budget. The bank was given the responsibility to set the interest rates on May 6, 1997. Before now, it was the treasury that set interest rates. PROBLEMS OF MONETARY CONTROL: Monetary control is normally designed in terms of target variable and the policy instruments that should be used to achieve the desired targets. Between the target variable and the instrument policy, there can be other variables. In the case of UK, having inflation target as the target variable, the instrument policy is being designed by the Bank of England, other variable is the interest rate. The strength or weakness of the relationship between the target variables and the policy instruments affect monetary control in one way or the other. It might be said to be in way of direct proportion, because the stronger the relationship, the more precise will monetary control be and vice versa. So changes in the relationship between the policies made, and the inflation target affect the interest rate. Among the problems of monetary control are: Unavailability of adequate information. Decision on the time frame within which the designed policies will be put into effect. Break in link of the relationship the policies and target. Being able to determine the aspects of the variables concerned - just as in cases where the Bank of England being in control the quantity of money in circulation, so there is need to specifically define what money is. CONCLUSION: From the above written essay, it has been money has been a contributing factor as far as human and societal development is concerned. And also inflation rate to be kept at the minimum, there must be monetary control. This is being taken care of in United Kingdom by the Bank of England - through the Monetary Policy of the Committee of the bank. 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