Question

Money is defined by its functions, explain what money is. Explain what assets best serve the functions of money why money is measured as M1 and M2 (along a liquidity continuum). Finally explain what causes money, like the “dollar” to have value.

Answer 1

Money refers to the any asset, precious item, or object that can be used as a medium of exchange and that can store value, duly recognized by the authorities. For example, coins, bank notes, currencies and other negotiable instruments are considered as money.

The best serving assets are coins, bank notes and currencies in circulation that are frequently used to buy and sell goods (medium of exchange). Afterwards, checkable deposits, checks, drafts are also treated as money. Less liquid assets such as mutual funds and time deposits also perform the function of money as they hold some value while doing some transactions. Besides, these money also work as a unit of account that can be used when a transaction takes place.

Money is measured as M1 or M2 on the basis of narrowed definition of money. The narrow definition considers money only on the basis of highest level of liquidity that is with the notes, coins and checkable deposits. But, M2 money has slightly broader definition that includes saving deposits. Money market securities and mutual funds along with the M1 money. So, M1 and M2 are the different classifications as per the broader nature of money.

The money holds value, because it is recognized by the government and it is legally enforceable in the court of law. So, money stores value.