Significance

Money is whatever can be used in order to settle payments. Nowadays, the most common kind of money are current accounts in the banks.

Cash, a self-evident component of money, has a short life out of the banks. Within few days is spent, for example in a shop, and the shopkeeper brings urgently cash back to a bank.

Money plays three main roles:

1. it is the medium of exchange that settle payments. People accept money in exchange of goods and services. Nothing is owed anymore.

2. money is the most common medium of account, i.e. it is the good some quantity of which serves as unit of account for prices. Prices are expressed using monetary expressions.

3. money is a store of value over time and across people, firms, countries. Selling things gives money that can be saved and spent in the future for many different goods and services. However, there exist other financial instruments - and even goods - that can serve as a store of value as well.

Composition

Money quantity is the nominal value of particularly "liquid" financial instruments in an economy. "Liquidity" means that an asset is easy to sell in any moment with small or no losses in respect to nominal price

There exist a few definitions of money quantity, some broader than others, i.e. including a wider range of financial instruments.

For the following definitions, a series of simplification has been taken to keep things easy. Moreover, there exist significant international differences in definitions, especially for broader money definitions (M2 and M3).

The narrowest definition of money, the monetary base comprehends only cash outside banks plus bank reserves, the latter including both cash reserves held by banks and banks' deposits at the central bank.

Larger than the monetary base, M1 comprehends cash and current accounts in banks.

M2 is M1 plus the savings account.

M3 is M2 plus other liquid liabilities of monetary financial institutions.

Thus, although a largely accepted image of money doesn't associate it to interest-bearing, some definitions do comprehend interest-bearing assets.

A crucial distinction is between nominal and real quantity of money, the latter being equal to the former divided by price level. In this way, real money dynamics becomes dependent on inflation.

This is particularly important, since inflation, in its turn, is dependent on nominal and real quantity of money, too.

Determinants

Narrowly-defined money is heavily influenced by central banks.

Instead, depositors, banks, financial and public institutions play a crucial role for broad money aggregates.

International money quantity, i.e. the national quantities of money converted in one common currency at the prevailing nominal exchange rates, is completely out of control.

With respect to the general economic climate, a booming economy usually exhibits a high growth of money quantity. By contrast, in hyperinflation, real money is drastically squeezed.

Impact on other variables

High growth rates in nominal money quantity, if clearly exeeding nominal GDP rates, can exert inflationary pressures.

If economic agents base their expectations about future inflation on the money quantity, one would expect the present inflation rate boosted by money quantity growth. But this is dependent on how present prices are influenced by mere expectations.

In many empirical instances, a certain increase of money quantity have turned out to be conducive to growth in real GDP.

Many short run acceleration or deceleration of the money quantity remain without any noticeable effects on other variables.

Long-term trends

Nominal money quantity has always grown, apart from few pathological events. Real money quantity has grown most of the time.

In hyperinflation episodes, real quantity of money sharply fell and remained at low levels for a long time.

Nominal money quantity is usually pro-cyclical, sometimes leading real GDP peaks.

Data

M1 data - a long-term yearly time-series for 19 countries (USA, UK, France, Germany, Japan, Greece,...)
Data for all the variables in IS-LM model
EU data for all the variables in IS-LM model (Germany, France, Italy, Spain, UK, Switzerland and other 13 European countries)

Formal models

An interactive map of how the economy works according to a basic macroeconomic scheme: the IS-LM model