Money in the modern economy: an introduction

5th May 2014

• Money is essential to the workings of a modern economy, but its nature has varied substantially over time. This article provides an introduction to what money is today.

• Money today is a type of IOU, but one that is special because everyone in the economy trusts that it will be accepted by other people in exchange for goods and services.

• There are three main types of money: currency, bank deposits and central bank reserves. Each represents an IOU from one sector of the economy to another. Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves.

Most people in the world use some form of money on a daily basis to buy or sell goods and services, to pay or get paid, or to write or settle contracts. Money is central to the workings of a modern economy. But despite its importance and widespread use, there is not universal agreement on what money actually is. That is partly because what has constituted money has varied over time and from place to place.

This article provides an introduction to the role of money in the modern economy. It does not assume any prior knowledge of economics before reading. The article begins by explaining the concept of money and what makes it special. It then sets out what counts as money in a modern economy such as the United Kingdom, where 97% of the money held by the public is in the form of deposits with banks, rather than currency.(1) It describes the different types of money, where they get their value from and how they are created. A box briefly outlines some recent developments in payment technologies. A companion piece to this Bulletin article, ‘Money creation in the modern economy’,(2) describes the process of money creation in more detail, and discusses the role of monetary policy and the central bank in that process. For expositional purposes this article concentrates on the United Kingdom, but the issues discussed are equally relevant to most economies today.
A short video explains some of the key topics covered in this article.

See the full article at -
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneyintro.pdf