The following three functions are sometimes considered to be the definitional
characteristics of money:
- It is a generally accepted medium of exchange.
- It is a store of value.
- It serves as a unit of account in which prices are quoted and books kept
(the numeraire).
On can argue, however, that the last function is on a di§erent footing compared to the two others. Thus, we should make a distinction between the functions that money necessarily performs, according to our deÖnition above, and the
functions that money usually performs. Property 1 and 2 certainly belong to the
essential characteristics of money. By its role as a device for making transactions
money helps an economy to avoid the need for a double coincidence of wants.
In order to perform this role, money must be a store of value, i.e., a device that
transfers and maintains value over time. The reason that people are willing to
exchange their goods for pieces of paper is exactly that these can later be used
to purchase other goods. As a store of value, however, money is dominated by
other stores of value such as bonds and shares that pay a higher rate of return.
When nevertheless there is a demand for money, it is due to the liquidity of this
store of value, that is, its service as a generally accepted medium of exchange.
Property 3, however, is not an indispensable function of money as we have
deÖned it. Though the money unit is usually used as the unit of account in which
prices are quoted, this function of money is conceptually distinct from the other
two functions and has sometimes been distinct in practice. During times of high
ináation, foreign currency has been used as a unit of account, whereas the local
money continued to be used as the medium of exchange. During the German
hyperinflation of 1922-23 US dollars were the unit of account used in parts of the
economy, whereas the mark was the medium of exchange; and during the Russian
hyperináation in the middle of the 1990s again US dollars were often the unit of
account, but the rouble was still the medium of exchange.
This is not to say that it is of little importance that money usually serves
as numeraire. Indeed, this function of money plays an important role for the
