3.2.4.1 - Money, financial markets and assets

Money and its supply

Money is an asset people generally accept in payment, rather than any asset that makes its owner wealthy.

Without money, barter requires a double coincidence of wants: each person must want what the other offers. A medium of exchange separates selling from buying. A unit of account lets people quote and compare prices in a common measure. A store of value transfers purchasing power into the future, although inflation reduces what a fixed money balance buys. A standard of deferred payment allows debts to be agreed and repaid in money over time. These functions reinforce each other: unreliable purchasing power makes long-term contracts harder to arrange.

Useful money is widely acceptable, portable, durable, divisible and recognisable, with a sufficiently controlled supply to support confidence in its value. Electronic deposits need not be physical objects: dependable records and payment systems perform the relevant functions. A debit card instructs a transfer of money; the card itself is not money. A credit card provides access to borrowing, rather than creating a new kind of money whenever it is used. A house is wealth and may store value, but cannot normally be handed over in small units at a supermarket.

The money supply is a stock of money at a point in time. Narrow money focuses on the most immediately spendable forms, especially notes and coins and, in some measures, immediately accessible deposits. Broad money also includes a wider range of bank and building-society deposits that can readily become spending power. Exact statistical definitions differ, so compare like measures rather than treating every reported money aggregate as identical. Central-bank reserves are banks' balances at the central bank; households cannot spend them directly in shops. More broad money is not automatically more real output: the result depends on spending, credit conditions and productive capacity.

Financial markets and the economy

Financial markets trade financial claims and connect people who provide funds with those who need finance.

The money market is not simply the market for notes and coins. Capital markets trade financial capital, rather than machines themselves. Foreign exchange supports trade, investment and international capital movements; a change in demand for a currency can change its price, the exchange rate.

In a primary market, a new share or bond is issued and the issuer receives finance. In a secondary market, an existing claim changes hands: the issuer does not receive the resale proceeds. Secondary trading still matters. An investor may be more willing to buy a new bond if it can later be sold, making long-term finance easier to raise. Market prices also convey information about expected returns and risks.

Finance can fund new equipment, working capital and innovation, supporting investment and productivity. Markets can spread risks among investors and allow savers to choose different combinations of return, risk and accessibility. This does not guarantee efficient allocation. Poor information, speculation and sudden loss of confidence can divert funds or interrupt finance to otherwise viable firms. The wider economy depends on the quality and continuity of financial services, not just the value of transactions.

Debt, equity and business finance

A firm must distinguish borrowing that creates a repayment obligation from selling a claim to ownership.

Debt commits the borrower to contractual payments. A bank loan is debt arranged with a lender; a corporate bond is a tradable debt claim issued to investors. Interest and repayment obligations remain even when profits disappoint, unless the borrower defaults or terms are renegotiated. Lenders do not normally acquire ownership simply by making a loan.

Equity is an ownership claim, commonly a share. Shareholders may receive dividends and gains from a higher share price, but neither is guaranteed. The firm normally has no obligation to repay the share capital on a fixed maturity date. New shares can dilute existing owners' voting power and their share of future profits. Dividends depend on profits and decisions to distribute them; retained profit can instead finance expansion.