The economy is a broad term that refers to an area that involves various economic activities. These activities can range from production, distribution, and trade. On top of that, the economy also includes consuming goods and services by participants within that area.
Usually, these activities are interrelated and impact how the economy operates. However, the economy doesn’t consist of those areas only.
The economy also handles how limited resources get allocated within the given activities that contribute to economic conditions. As stated above, those activities may differ based on some conditions.
Together, these activities constitute the economic system of a nation. The term economic can have other definitions as well. Nonetheless, the most common areas it concerns include the ones mentioned above.
Most people associate the economy with money and finances involved in running a country. In any economy, money plays a crucial role in stimulating economic growth.
It dictates how various areas interrelate and interact. Usually, the monetary system within an economy determines how money gets handled within it. This system can have many types and differs from one area to another.
What is Money?
Money defines the economic unit that economists use as a medium of exchange. This medium gets used for transactional purposes in any economy. Usually, money can have various forms within an economy.
It provides several functions within an economy. These may also include reducing transaction costs. Usually, money gets generated in the economy in a commodity form.
In an economy, money acts as a currency. This currency may differ from one area to another. For example, the currency used in the USA varies from that prevalent in the UK.
Nowadays, cryptocurrencies also serve as a type of money. For most nations, it is the most liquid asset that participants can use to settle deals. Money also comes with a general acceptance value that determines its value within an economy.
Money can also refer to the paper currency in circulation within a nation. However, its value does not come from its form. Economists do not use the cost of the materials used to produce notes or coins to evaluate money.
Instead, they derive it from how willing market participants are to agree to its displayed value. Furthermore, its reliance on future use also plays a crucial role in determining the value of money in an economy.
Apart from within the economy, money can also have value internationally. Usually, it acts as an exchange medium within a nation. However, it can also hold value within global economies.
This value also comes from the willingness of international participants to accept it as an exchange medium. All these areas get impacted by the monetary system within the economy to which the money relates.
Overall, money refers to an exchange medium within an economy. However, it can also have its uses in the international market. The term money can refer to various areas in an economy.
Usually, these areas relate to each other. The use of money and the term itself comes from several centuries ago. Currently, it is the most liquid asset that participants can hold within an economy. The monetary system within an economy can impact its behavior.
What is a Monetary System?
A monetary system refers to the process to provide money to an economy. This system can encompass various areas. Usually, these include the national treasury, the central and commercial banks, and the mint.
These areas dictate the flow and production of money within an economy. Governments can also use various policies to determine the monetary system and its components.
The monetary system can also refer to the institutions that provide a supportive framework for money. Usually, these include the parties listed above. They consist of the government, the central and commercial banks, and the mint. Their efforts go into determining the creation of money within an economy. These parties also play a role in establishing the monetary system within the economy.
However, a monetary system does not encompass those institutions only. They also include various other areas that dictate money flow within an economy. These also involve the policies and frameworks governments use to create money in the economy. Together, these areas dictate the overall monetary system utilized within a nation. Based on these factors, it may differ from one country to another.
The term monetary system may also relate to the international system. In that case, it refers to the operating system of the financial environment. There, it includes financial institutions, investors, and multinational corporations.
The international monetary system helps determine the rules and regulations around international payments. Similarly, it dictates the exchange rates and capital movements in those areas.
Overall, a monetary system encompasses various areas that dictate the creation of money within an economy. However, it does not have limited scope to a specific nation.
The term may also cover the international monetary system that facilitates international transactions. Various parties contribute to the processes and frameworks within monetary systems. This system may come in several types.
What are the three important types of Monetary Systems?
A monetary system can follow one of the three important types. The fiat money type is the most common in the world. However, the other ones are also crucial to understand. An explanation of the three types of a monetary system is as follows.
Commodity money refers to money that derives its value from an underlying commodity. It usually includes objectives that have an intrinsic value. Similarly, they have worth in buying goods.
Commodity money usually includes precious metals and other similar items. Since these have an intrinsic value and can act as an exchange medium, they can fall under this type.
Commodity money uses physical commodities to derive its value. This type maintains its value despite any changes in the physical form. On top of that, it also derives its value from those physical characteristics that differentiate them from others. This money may also include a mark to mark its weight or value.
Commodity-backed money may sound similar to the above type. However, it differs significantly. In this system, the underlying currency derives its value from a commodity. However, it does not use that commodity as an exchange medium. Instead, it backs a currency based on that commodity. These may include back-issued notes.
Although these notes have no value, they can get exchanged for commodities. In this case, these commodities include precious metals such as gold or silver. Therefore, it derives its value from those metals. However, it does not involve handling that commodity itself. The notes using those metals as backing do not have any value.
As mentioned above, fiat money is the most common form of monetary system prevalent worldwide. In this system, the currency does not use commodities or backing.
Instead, it gets declared by a decree from the government to be legal tender. Therefore, the legal notes have a value of their own. This value does not come from commodities or items governments use as backing.
Fiat money has become a prevalent alternative to commodity money. It may have some similarities to the commodity-backed monetary system. However, it does not have any backing. Nowadays, most currencies use the fiat money system for value. This money usually exists in the form of bank balances and records. These also contain credit or debit card purchases.
The monetary system in a nation dictates the creation of money by the government. Usually, it comes under three types. Commodity money uses commodities as the exchange medium.
However, the same does not apply to commodity-backed money. In that system, money derives its value from commodity backing. Lastly, fiat money gets its value from a government-declared decree.