Glossary
Commodity Money
Money that has intrinsic value in itself, apart from its use as money.
Example:
Historically, gold was used as commodity money because it was valuable for jewelry and industry, even if it wasn't used for transactions.
Fiat Money
Money that has value because a government has declared it to be legal tender, not because it has inherent value.
Example:
The paper bills and coins in your wallet are fiat money; they are accepted for transactions because the government mandates their use, not because the paper itself is valuable.
Liquidity
The ease with which an asset can be converted into cash without a significant loss in value.
Example:
Cash is the most liquid asset because it can be immediately used for purchases, whereas real estate has low liquidity as it takes time to sell.
M1
The narrowest measure of the money supply, including the most liquid forms of money: physical currency, checking deposits, and traveler's checks.
Example:
If you add up all the cash in people's wallets and the balances in their checking accounts, you are calculating a significant portion of M1.
M2
A broader measure of the money supply that includes all of M1 plus less liquid assets like savings deposits, small time deposits, and money market mutual funds.
Example:
When economists discuss the total amount of money available for spending and saving in the economy, they often refer to M2, which includes both highly liquid funds and easily accessible savings.
Medium of Exchange
One of the three functions of money, allowing it to be used to facilitate transactions without the need for bartering.
Example:
Using your debit card to pay for groceries at the supermarket is an example of money acting as a medium of exchange, simplifying the trade.
Monetary Base (M0 or MB)
The sum of physical currency in circulation and commercial banks' reserves held at the central bank; it is the foundation upon which the money supply is built but is not part of the money supply itself.
Example:
When the Federal Reserve conducts an open market operation by buying bonds, it directly increases the monetary base by adding reserves to the banking system.
Money
Anything that serves as a medium of exchange, a unit of account, and a store of value.
Example:
In a modern economy, the U.S. dollar functions as money because it can be used to buy goods, price items, and save for the future.
Money Supply
The total amount of money available in an economy at a specific point in time, typically measured by M1 and M2.
Example:
If the central bank wants to stimulate economic growth, it might aim to increase the money supply by making it easier for banks to lend.
Store of Value
One of the three functions of money, allowing it to retain its purchasing power over time.
Example:
Saving a portion of your summer job earnings in a bank account to pay for college tuition next year demonstrates money's function as a store of value.
Unit of Account
One of the three functions of money, providing a common measure of value for goods and services.
Example:
When you compare the price of a new smartphone at 300, money is serving as a unit of account, allowing for easy value comparison.