what is not money?

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WHAT IS (NOT) MONEY?

MEDIUM OE EXCHANGE MEANS O F PAYMENT

by Bill Z. Yang*

Abstract

This note attempts to provide a formulaic defmition of money and discuss the distinction between

medium of excha nge and mean s of payment. The former refers to the set of assets in an economy

that people regularly exch ange for goods and services (a concept of

what ),

while the latter is a method

that facilitates delivery of money from one to another (a notion of ho w ). It suggests that money should

be exclusively defined as medium of exchange , rather than mean s of payment. With such a distinc-

tion established, one can uniformly explain why currency, demand deposits and smart cards are money

(because they are a medium of exchange), and why checks, money orders, or debit and credit cards are

not money (because they are only a means of payment but not a medium of exchange).

1.

Introduction

What is money? In economics, it is unanimously

defined as the

medium of exchange.

But its inter-

pretation varies from author to author. Some

authors refer to med ium of exchang e as anything

that is generally accepted as payment for goods and

services or in the settlement of de bts (Hubb ard,

2005 , p. 14),' white others use it as a synonym of

means of payment

(e.g., Thomas, 2006, p. 21).

These treatments, however, are not only pedagogi-

cally troublesome but also conceptually incorrect.

For example, almost all students get very confused

when told check is not money, in particular, right

after they had jus t learnt that m one y is anyth ing

that is generally accepted as paym ent. The stan-

dard argum ent in most textbooks is that check is

not money but the checking deposits are without

explaining why a check is not money. Mumbles

from s tuden ts wo uld often be A chec k is indeed

generally accepted as payment, by definition, why

isn 't it money? If a check is not money, then what is

i t?

To our knowledge, no textbook has directly

answered these questions. Therefore, it is necessary

to define money correctly so that one can easily

judg e whether a comm only-used means of pay-

men t is money, by deflnition.

This note is intended to provide such a formula-

ic definition of money. We define money as

medi-

um of exchange—the set of assets in an economy

that people regularly exchange for goods an

services from others. There are two key points

this definition. First, money must be an

asset

th

signifies a part of what its holder owns. Secon

people normally convert their assets from oth

forms to this specific one before exchanging fo

goods and services, implying that this set of asse

are generally accepted in transactions. By defin

tion, currency and demand deposits are money

while checks, credit and debit cards are not. This

because currency and checking deposits are the

owner's assets, whereas a check or a credit/deb

card is not a part of its owner's assets.

The n, wh at is check if it is not mo ney? W hy is

generally accepted in transac tions ? ChecJcs

well as debit cards, credit cards and money order

etc., are a means of payment, referred to as a ge

erally accepted (institutional) arrangement o

method that facilitates delivery of money from

one to another. For example, a (signed) che

essentially serves as a standardized permit th

authorizes the recipient to claim a certain am ount o

checkable deposits from the check writer's ban

account, but the check itself does not signify an

part of the writer's assets. That is, a check is

means of payment and hence generally accepted i

transactions, though it is not a medium of exchang

Conceptually, medium of exchange should NO

be used as a synonym of

means of payment;

th

medium of exchange stands for

what

(is paid

School of Econom ic Development, Georgia Southem University, Statesboro, GA 30460 -8152, E-mai



and the means of payment concems "how" (to

deliver it). Once such a distinction is clarified, one

can uniformly explain why currency, checkable

deposits, and stored-value cards are money, and

why checks, debit/credit cards, or money orders are

not money. It is beca use the former are a medium of

exchange, whereas the latter are a means of pay-

ment but not a medium of exchange.

2.

Medium of exchange

payment

means of

Characterized by its primary function,^ money in

economics is defined as

medium of exchange.

This

defmition is perhaps universally adopted by all

economists . Interpretat ions for "medium of

exchange" differ, however. For example, many

authors refer to medium of exchange as "anything

that is generally accepted as payment,"' and others

treat medium of exchange as a synonym of means

of payment. These treatments have caused lots of

confusion in the classroom: following the definition

students would conclude that a check is money,

because a check is a means of paym ent and "gener-

ally accepted as payment." But they were immedi-

ately told that a check is not money Confused? Of

cou rse Such confusion stems from the above inter-

pretations for medium of exchange; they are con-

ceptually incorrect

We now provide a correct and formulaic defini-

tion of money; following it one can directly judge

whether or not a means of payment is money,

hy

definition.

We also articulate why "medium of

exchange" and "means of payment" are two differ-

ent concepts, and hence why money should be

exclusively defined as a medium of exchange but

not a means of payment.

As illustrated in Figure 1, the term "medium of

exchange" is sufficiently self-explanatory; when

one plans to trade something for something else

from another, she first converts it to a medium of

exchange, and then trades the medium of exchan

for what she wants to buy. A medium of exchan

has two key features: First, it represents a part of

owner's assets; second, it is commonly accepted

transactions. We refer to medium of exchange

the set of assets in an economy that people reg

larly exchange for goods and services.^

In a modern payment system, an exchan

process essen tially takes two steps. At step 1, pote

tial buyers allocate a part of their assets in the fo

of, or directly exchange their goods or services f

a specific type of assets that is ready to make pa

ment. For example, when one works and gets pa

she actually trades her labor service for ba

deposits or currency. At step 2, buyers exchan

their bank deposits or currency for goods and s

vices from sellers. Clearly, checkable deposits a

currency are a part of people's assets and serve a

medium of exchange in transactions. By definitio

checkable deposits and currency are money.

A related question is: How do buyers deliv

money to sellers? In other words, how to make pa

ment? In the real world, people have gradua

developed a variety of means of payment—gen

ally accepted inst itut ional arrangements

methods that facilitate delivery of money fro

one to another. For example, a buyer may wi

draw currency from her bank account or ATM a

then hand-to-hand deliver it to make payment.

this case, currency also serves as the ultimate me a

of payment; when cash changes hands, payment

made and exchange is completed.

To deliver cash hand to hand is not the on

means of payment, however. Writing checks

another very popular method to make payme

Unlike cash, a signed check itself does not car

any value of the check writer. In fact, it only pla

a role of a

standardized permit

that authorizes

recipient to claim a certain amount of checkab

deposits from the check writer 's bank account. As

signed check changes hands, payment is not rea

completed until the recipient has finally receiv

Assets

(Medium of exchange)

Money

Buyer

Seller

Goods or services



the funds, as illustrated in Figure 2. That is, writing

a check is an institutional arrangement that facili-

tates transfer of demand deposits from one's

account to another's, but the check itself is not a

medium of exchange. By definition, check is a

means of payment but not money.

In general, money serves as the ultimate means

of payment (Shiller,

2003 ,

p. 206), but not every

means of payment must be money. This is because,

by definition, a mediu m of exchange conveys a part

of one's assets ready to be traded for good s and ser-

vices from other people, whereas a means of pay-

ment (e.g., checks) may not carry any value and

only help deliver money. In other words, med ium of

exchan ge is a concept of

what

is to be paid , wh ile

means of payment is a notion of how to deliver it.

Hence, medium of exchange and means of

payment are NOT synonymou s. Therefore, we

should not refer to money as a means of payment,

or anything that is generally accepted as payment.

Rather, money should be

exclusively

defined as

medium of exchange—the set of assets in an

economy that people regularly exchange for

goods and services.

Pedagogically, a good definition (of money)

should be formulaic; following it one can conclude

correctly what is money and what is not money. By

definition, a means of payment is generally accept-

ed in transactions, because it is institutionally

backed by the current payment system. To deter-

mine whether a specific means of payment is

money, a simple criterion is to see whether it car-

ries value, physically or digitally. With such a cri-

terion, for example, one can elucidate why e-cash

and store-valued cards are also money, becau se they

convey their holders' assets digitally. Likewise, one

can explain for why debit cards, e-checks, money

orders, bank checks, traveler's checks, credit cards,

etc. are not money, because they do not carry any

part of payers' assets and only help deliver money

under a commonly accepted institutional arrange-

ment.'*

3.

Functions of some often-used

means of payment

In the previous section, we compared a check t

a standardized permit. W hat about other non

money means of payment? Since debit cards and e

checks are just electronic version of chec ks, the

can be interpreted as e-permit. Similarly, mone

order, cashier's check and traveler's check essen

tially serve as standardized receipts. Their issue

plays a role of gene ral cashier, wo rking for a

recipients. For example, when one buys a mone

order from post office with cash, the money is pai

to this cas hier (the post office), wh ile the m one

order is the receipt with which the recipient wi

claim the payment from the issuer later.

Table 1 lists some often-used means of pay men

and their functions.

Conclusion

This note is intended to provide a correct an

formulaic definition of money; with it that one ca

easily determine what is money and what is n

money. We emphasize two points: First, medium o

exchange and means of payment are not synony

mous; medium of exchange is the set of assets in a

economy that people regularly exchange for good

or services, while a means of payment is a genera

ly accepted institutional arrangement or metho

that facilitates delivery of money from one to anoth

er. Second, m oney should be exclusively defined a

medium of exchange but not means of payment o

anything that is generally accepted as payment

With such a distincdon established, one can explai

consistently w hether or not a specific means of pa y

men t is money and why. It may help to bett

understand the concept of money in economics an

avoid unnecessary confusions caused by the con

ventional but incorrect definitions of money.

M o n e y

Checking deposi ts

Assets

Buyer O j e ^ (_£.P££niii) ^

<

Seller



TABLE 1

Functions of some often-used means of payment

Means of payment

Functions

Does it carry one's assets?

Is it money

Currency

Checking deposits

E-cash

Stored-value cards

Checks

E-checks

Debit cards

Credit cards

Money orders

Cashier checks

Traveler 's checks

Medium of exchange

Medium of exchange

E-briefcase

E-wallet

Permit

E-Permit

ID/Permit

ID/IOU

Receipts

Receipts

Receipts

Yes

Yes

Yes

Yes

N o

N o

N o

N o

N o

N o

N o

Yes

Yes

Yes

Yes

N o

N o

N o

N o

No

N o

N o

Footnotes

1.

Similar interpretations for medium of exchan ge

can also be found in, for example, Mishkin

(2004,

p. 45), Thomas (2006, p. 19), and Bade

and Parkin (2002, p. 253), among others.

2.

Mo ney has three (or four) functions: Me dium

of exchange (the primary one). Unit of account

and Store of value (some authors add the fourth

—Standard of deferred payment). We use an

acronym MUSt to help our students remember

these functions with ease.

3. For exam ple, see Hub bard (200 4, p. 14),

Mishkin (2004, p. 44), Thomas (2006, p. 19),

and Burton and Lombra (2005, p. 24), among

others.

4 .

For exam ple, see Burton and Lom bra (2006 , p.

24), Miller and VanHoose (20 04, p.6), and Bau -

mol and Blinder (1999, p. 626), among others.

5.

Ou r definition for mo ney is very close to

Mankiw 's (2003, p. 220 ): Mo ney is the set of

assets in the economy that people regularly use

to buy goods and services from other people.

Frank and Bemanke (2004, p. 596) also share a

very sim ilar definition. We replace use [it] to

buy by exchan ge [it] for to emp hasize the

difference between a medium of exchange and

means of payment. For example, when people

use checks to buy goods and services from

other people, they do not exchange checks for

goods and services; rather, they mean to

exchange their checking deposits for goods and

services.

6. A practical way to jud ge whether a mean s

payment carries value is whether you can ha

your m on ey back with an institution

arrangement through the payment system,

you happen to lose it.

References

Baumol, William J., and Alan S. Blinder, 199

Economics: Principles and Policy 8th Editio

Dry den.

Bade, Robin, and Michael Parkin, 2002.

Found

tions of Macroeconomics Addison Wesley.

Burton, and Lombra, 2006. The Financial Syste

and the Economy: Principles of Money a

Banking

4th Edition, Thomson South-Western

Frank, Robert H. and Ben S. Bemanke, 2004.

Pri

ciples of Economics

2nd Edition, Irwin McGra

Hill.

Hubbard, Glenn, 2004. M oney the Financial Sy

tem

and the Economy

5th Edition, Pears

Addison Wesley.

Mankiw, N. Gregory, 2004.

Brief Principles

Macroeconomics

3rd Edition, Thomson Sout

Westem.

Mishkin, Frederic S., 2004. The Economics

Money Banking and Financial Markets

7

Edition, Pearson Addison Wesley.

Shiller, Robert,

2003.

The New Financial Orde

Princeton: Princeton University Press.

Thomas, Lloyd B., 2006.

Money Banking an

Financial Markets

Thomson South-Wester.

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