4 Different Approaches to the Definition of Money– Explained!

Money is only one of many kinds of financial assets which consumers, government and business firms hold in their asset portfolios. However, economists’ emphasis on money per se is justified because unlike other financial assets, money is the essential ingredient in conducting most economic transactions in the economy (savings deposits, government and corporate bonds). Furthermore, the demand for money is a derived demand.

Money performs four essential functions as a unit of account, a medium of exchange, a store of value and a standard of deferred payments and other goods perform one or two but not all the monetary functions in the economy. The following discussions set out the four different approaches to the definition of money:

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Different Approaches

1. Conventional Approach:

The conventional approach to the definition of money is the oldest approach. According to this approach, the most important function of money in society is to act as a medium of exchange. Money is what money does.

It pays for all the goods and services transacted in the community. Consequently anything is money which functions generally as a medium of exchange in the economy.

According to Hawtrey, money is one of those concepts which are definable primarily by the purpose which they serve.

Following this approach, Crowther has stated that money is anything that is generally acceptable as a means of exchange (i.e. as a means of settling debts) and, at the same time, acts as a measure and store of value.

Defined on the basis of its functions as a medium of exchange, a nation’s total stock of money would comprise those things which are generally accepted as the means of payment.

This definition of money includes only the currency and the demand deposits in commercial banks as constituting the supply of money i.e. M=C+D.

It excludes the time deposits in commercial banks and postal saving deposits. The reason for excluding the time deposits from aggregate money supply is that such deposits must be converted into either currency or demand deposits before these can be spent.

Many other assets like short-term treasury securities, savings bonds etc. possess high liquidity in as much as these can be converted into cash or demand deposits with little loss or risk.

2. Chicago Approach:

The Chicago Approach to the concept of money is associated with the views of Prof. Milton Friedman and other monetary theorists of the University of Chicago.

The Chicago economists have adopted a broader definition of money by including in it besides the currency and chequable or demand deposits, the commercial bank time deposits—fixed interest-bearing deposits placed with the commercial banks.

Obviously the Chicago Approach to the definition of money conflicts with the conventional approach to the definition of money since commercial bank time deposits are not directly spendable; these do not function as a medium of exchange.

For example, if a man owns a fixed time deposit receipt worth Rs. 2000 in commercial bank and wants to use it to buy a TV, he must first exchange his time deposit for currency or demand deposit which can be used to make payment for the purchase of TV.

The economists of the Chicago School have advanced two reasons for including time deposits placed with the commercial banks in their definition of money.

First, national income highly correlated with money as they have defined it than with money when it is alternatively defined.

Since changes in the money supply bring about predictable changes in national income, their definition comes very close to satisfying the empirical criterion of putting the monitory theory in a good light.

Second, the Chicago Approach is based on the theoretical criterion of including in the definition of a single commodity all those things which are perfect substitutes for each other.

It is argued by the supporters of the Chicago Approach that commercial bank time deposits are very close substitutes for currency and demand deposits.

In practice, time deposits are almost as readily available for spending as are demand deposits or currency since most banks make time deposits available to their customers on demand, although they may require a waiting period of some 30 to 60 days.

Consequently, it is better to treat the time deposits in banks as if these were perfect substitutes for currency and demand deposits rather than not to treat them so.

3. Gurley and Shaw Approach:

According to John Gurley and Edward Shaw approach, currency and demand deposits are just two among the many claims against financial intermediaries.

They emphasise the close substitution relationship between currency, demand deposits, and commercial bank time deposits, saving bank deposits, credit institutions’ shares and bonds etc. all of which are regarded as alternative liquid stores of value by the public.

The Gurley and Shaw approach to the definition of money is akin to the Chicago approach in its objective.

Both the approaches include in money the means of payment and those assets which are close substitutes for the means of payment. Despite this similarity, the Gurley and Shaw approach is, however, different from the Chicago approach in its analysis.

Unlike the Chicago approach which considers only time deposits of commercial banks as being close substitutes for the means of payment, the Gurley and Shaw approach includes in the list of close substitutes for the means of payment the deposits of and the claims against all types of financial intermediaries.

4. Central Bank Approach:

This approach which has been favoured by the Central Banking authorities, take the broadest possible view of money as though it were synonymous with credit funds lent to the borrowers.

The supporters of the Central Bank approach have agreed that similarity between money and other means of financing purchases justifies the use of much broader concept of money, measurable or unmeasurable.

Money is identified with the credit extended by a wide variety of sources. The reason for identifying money with credit used in the broadest possible sense of the term lies in the Central Bank’s historic position that total credit availability constitutes the key variable for regulating the economy.

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