Inflation and Functions of Money Essay

Published: 2020-02-06 02:00:29
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Category: Money

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Money refers to any commodity which functions as medium of exchange or the settlement of a debt. In a modern economy bank notes and coins clearly form part of the money supply as they are acceptable in the settlement of all transactions. Moreover some transactions are settled by cheques drawn on bank deposits in current accounts (also known as sight or demand deposits). Thus current account deposits also form part of money supply. Deposits accounts with banks and other financial institutions are also included in the supply of money.

Money can also be conceived in terms of narrow money and broad money. Narrow money refers to money balances easily available to finance day to day transactions. In other words it considers the medium of exchange function of money. Broad money refers to money held both for transactions purposes and as a form of saving. It also considers assets which can be easily converted into cash. Therefore the broad money version of money considers both the medium of exchange and store of value function of money.

The effects of inflation on the function of money depend on the rate of increase inflation. For example a mild inflation will have no effects on the function of money. However, as the rate of inflation increases the ability of money to fulfil its functions is negatively affected. The effects of hyper inflation on the function of money are described below

Medium of exchange By medium of exchange it is meant money is used to carry on daily transactions. Money eliminates the need for double coincidence of wants. However, hyper-inflation causes the value of money to fall significantly and nobody will want to hold money. Thus, since money will not be readily acceptable money stop functioning as medium exchange.

Store of value Money allows an individual to postpone purchases. By storing money an individual is said to be storing wealth because with money someone is able to purchase goods and services in the future. But inflation causes the value of money to fall which means that the ability to buy in the future in reduced. Thus no one will want to holds money as its value will be falling meaning that less goods and services will be able to be purchased.

Unit of account Money allows units of goods and services to be priced. This facilitates easy and quick comparisons of the values of different goods. As a consequence of the fall in the value of money due to rapid increases in prices comparisons become difficult. Thus the public will try to find alternative ways to measure the value of goods and services.

Standard of deferred payment Money also allows credit transactions to take place. Goods and services can be purchased now and payments made later. Inflation causes creditors to lose and debtors to gain. Therefore this discourages credit transactions. Moreover, it also discourages borrowing and lending since borrowers normally benefit as lenders are the victims of inflation.

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