According to definitions:
“Money is a commodity which is generally acceptable as a medium of exchange and at the same time it acts as a measure and a store of value”.
This is the reason that Prof. Sigwick says:
“Money is what, what money does”.
Thus the economists agree that anything which is to serve as money should be:
(i) Generally acceptable.
(ii) Could be used to measure the values of goods and services.
(iii) Could be used to store the values.
Thus keeping in view the above mentioned role and functions of money the experts follow the following methods to define money:
(1) Transaction Approach which accords money as a medium of exchange.
(2) Liquidity Approach which accords money as a temporary store of value.
(3) Scientific Construct Approach which accords money as a measure of value. All are discussed below in turn.
(1) Transaction Approach of Money:
According to transaction approach only those commodities will be included in money which are just “Medium of Exchange”. Thus all those goods which facilitate the sale or purchase of goods, or which facilitate the transaction of goods and services can be given the name of money. Hence, in the light of such approach to be money a commodity must have the quality of medium of exchange. As a result, the coins and currency notes which are issued by central bank and govt. and cheques of demand deposits which are issued by commercial banks will be called money. They are considered as money because they can be used to purchase goods and services. Thus according to this approach money consists of (i) legal money and (ii) demand deposits. It is written as:
M = CU + DD
M represents quantity of money, CU = currency and DD = demand deposits.
It must be remembered that this approach to define money corresponds to classical theories. As classical economists accord money just as a medium of exchange. Money according to classical is just a token which is employed to purchase goods and services. Money can not influence the economic activity.
To define money through transaction approach is beneficial from following point of view:
(i) The money which is used to carry out the transactions can easily be controlled by central bank. Accordingly, the value of such money is stable.
(ii) On the basis of transactive approach, the relationships between money and economic objectives can easily be predicted.
The money which people possess to meet the daily needs is also given the name “Spending Money”. But with the passage of time people got the realization that whatsoever they keep in the form of coins, currency and demand deposits does not yield any return, i.e., they have to lose interest what they could have earned against them. In this way, the possibilities in the development of definition of money took place and a new definition of money came forward.
(2) Liquidity Approach of Money:
Money is not just a medium of exchange, it is also a store of value. As Prof. Gurly and Shaw says:
“Money as a store of value is an important property of money”.
Thus money should not include only currency and demand deposits, the assets should also be added in money. Thus according to this definition, “Money is like an asset”, or money is like ‘Reserve Purchasing Power’ which people keep with them during the interim period of earning and spending. Thus according to this definition of money:
“All those goods which have the quality of reserve purchasing power be also included in money”.
In the light of this theory we will add all those goods in money which are liquid. The liquidity represents how soon an asset with low costs can be used to purchase goods and services. In this way, not only currency but all other monetary and non-monetary assets like shares, bonds, houses, vehicles and shops will also be included in money. Because all these assets have the quality of money as a store of value. However, the degree of liquidity varies from assets to assets. It is the money which is the most liquid asset and it has not to converted in any other asset. As one rupee note remains one rupee note can be spent whenever one likes. On the other hand, house is also an asset, but it is not as liquid as one rupee. The sale of house will require time when as an asset it is converted into money.
Thus according to liquidity approach money is not just a medium of exchange, it is something more than that. Normally all those goods which are medium of exchange also possess the quality of store of value. As the currency notes and demand deposits are not only medium of exchange, but they also serve as store of value. However, there are certain goods which have the quality of store of value, but they cannot be used as a medium of exchange, as the case of saving and time deposits of commercial banks. The such like deposits can not be withdrawn from banks readily and they can not be used for transactions. Therefore, these deposits represent just store of value. Thus it is- said that all those goods which are medium of exchange also have the property of store of value. While those goods which have the quality of store of value can not perform the function medium of exchange. It is shown as:
This figure shows that currency, demand deposits and traveler’s cheques have the quality of medium of exchange (shown in the smaller circle). In addition to them if we include time deposits, mutual saving bank accounts and treasury bills we get all those goods which have the quality of money as a store of value. Thus if money is shown in a set, the money as a store of value will represent universal set while money as a medium of exchange will be a sub-set of this universal set.
Thus according to liquidity approach all those assets whose nominal value neither increases nor decreases and they can easily be spent are called money. While those assets which experience slight rise in their value are known as Near Money, as the case of gold, silver and prize bonds etc. Finally we conclude by saying that according to liquidity approach money will be consisting of coins currency, demand deposits, saving bank deposits, fixed deposits and treasury bills etc.
This must be kept in view that the philosophy of money as a medium of exchange is concerned with Keynesian thinking. As Keynes was of the view that money is not just a medium of exchange, but people have also the desire to save so that they could face unexpected circumstances. Moreover, people also save to earn interest or take advantage in the prices of goods and services. According to Keynes money can influence the economy through its role as a reserve purchasing power.
(3) Scientific Construct Approach of Money or Modern Approach of Money:
This approach to define money is concerned with Milton Friedman and his followers. As Friedman says:
“Money is not just a summation of medium of exchange and store of value, rather it is a scientific construct which has been invented for so many useful purposes”.
Friedman further says, money is anything which is helpful to us in many ways. It is not any thing which was exiting earlier, and now it has been discovered like USA, rather it is a scientific measure which has been invented like the measures in physics to measure length, temperature and power etc. Thus according to modem economists:
“Money is anything which can be employed to measure the value of goods and services”.
As length of anything can be represented with the help of yardstick. In the same way, the values of goods can be represented with the help of money; national income can be shown with money; exports and imports can be shown with, the help of money; the domestic and foreign loans can be expressed with money; and the factor prices can be represented into monetary values with money.