Notes on money

Money is a medium of exchange. When exchanging A for B, we prefer to exchange A for money and then money  for B.

Money is a store of value. On top of holding money temporarily while exchanging A for B, we also hold money when we haven’t determined what B we want yet. Holding money is preferable to holding A because A might be bothersome to store (e.g., a truckload of sand) or it might become less valuable with time (e.g., a truckload of apples).

The usefulness of money gives rise to a liquidity preference. Keynes enumerated three ways in which money is useful: as a buffer to smooth out short-term volatility (known unknowns) in income and expenditure, for use as emergency reserves (unknown unknowns), and for use in speculation, i.e., using knowledge of prices to buy assets at low prices and sell them at high prices. The first two forms of liquidity preference tend to grow with income, whilst the last is more affected by the interest rate and expectations of future interest rates.

When the economy is in a state of equilibrium, each party holds a constant amount of money, and it is possible to think of the flow of money as consisting of many cases of multiparty barter, i.e., every dollar flows in a circle, with goods and services flowing in the opposite direction. This money flux is the GDP, and is a measure of economic activity.

Some goods are not directly consumed, and instead are used to produce other goods and services – these are called investment goods. The accumulation of investment goods increases production.

When stimulating the economy by printing money, one dumps money into certain regions, and that money proceeds to flow outwards from the introduction points. Iff that flow results in the accumulation of investment goods, the economy is successfully stimulated.

Comments are closed.