It seems appropriate to start a series on money and banking with a precise definition of money—particularly after I ridiculed Mr. Ben Bernanke for not adequately defining a dollar. In this article I will provide a good working definition of money. I will describe briefly the key elements in this definition. Then, having provided this background, I will provide more discussion about these elements in other articles in this series.
Money consists of any economic good, or any claim on such a good, that serves as a general medium of indirect exchange and that acts as a final means of payment.
The key phrases, or primary elements, of this definition consist of: economic good, general, medium of indirect exchange, and final means of payment. I will describe each of these elements separately.
The term economic good has specific meaning in economics. A good consists of any resource that satisfies a human need. A good becomes an economic good when the need for that resource exceeds the available quantities.
This definition also includes the phrase “or any claim on such a good.” This phrase means that any form of money substitute—such as bank notes and checking accounts—also fills this broad definition of money. The inclusion of this characteristic plays an important role in understanding the money used in our current economic structure.
The concepts of subjective value and marginal utility apply to money, just as they do to any economic good. We will see in later discussions, however, that varying quantities of money do not add or detract from economic well-being, but they do affect economic decisions.
Medium of Indirect Exchange
The role of money as a medium of indirect exchange distinguishes it from most other economic goods. Unlike other economic goods the value of money to the owner lies not in its utility but in its acceptance in exchanged for other economic goods. Many people, including many economists, forget to include this important distinction in their definition, and understanding, of money. Money gains value and utility with its acceptance in exchange for other goods.
The word general plays a significant role in the precise definition of money. People can use any economic goods as media for indirect exchange. The word general implies a wide acceptance of a particular good in those exchanges. Because of that wide, or general, acceptance, people have confidence that a wide range of people will accept units of that good in exchanges for other goods.
Final Means of Payment
When a person accepts money in an exchange, he knows that it requires no further conversion in order to be used in future exchanges. This phrase in the definition of money excludes items like credit cards or IOUs, which require the receiver to take further action in order to take ownership of an economic good.
I should acknowledge that this definition does not include some of the characteristics that people frequently include in their definition of money, for example a store of value or a unit of account. These characteristics do not define money. Instead they become uses for money as defined.
A precise definition of money provides a good background for further discussions of the subject of money and banking. I plan to expand my description of some of these elements of money in future articles.