Money serves several purposes and functions in any economy. Money can be described as anything which is generally accepted as a medium of exchange in the economy. Money serves the function of a medium of exchange to facilitate economic transactions. Without money as a medium of exchange, all transactions of exchange would be conducted in barter trade which has numerous shortcomings like indivisibility and lack of double coincidence of wants. Money also acts as a store of value because money usually holds its value over a period of time. Other physical stores of value like cars and real estate exist but money is universally accepted in all transactions hence it’s a good measure of the value and a good store of the value because of its liquid nature. Money is a unit of account since it provides a common acceptable measure of value for goods and services which are priced in monetary terms. Money serves the purpose of transferring immovable assets like building which are just priced in monetary terms and the owner is allowed to go an invest in another place. Money serves the functions of a standard of deferred payment where future obligations to be fulfilled are measured and quantified in monetary terms. Money plays the purpose of a standardized unit of measure of value due to it’s generally acceptability quality and the divisibility in to small units characteristic hence this facilitates trade in the economy when all goods and services are priced in monetary terms (Makinen & Labonte, 2006).
The central bank usually manages the national monetary system through its various functions which affect the supply of money and the rates of interest in the markets. The central bank usually supervises the activities of all commercial banks in the economy by requiring them to meet the necessary capitalization and protection of customers’ deposits. The central bank licenses new commercial banks and issues bank notes and coins. The central bank also acts as the bank for the government and usually receives government revenues in form of taxes and borrows funds in the market in form of issuing treasury bonds and bills which are used in financing government expenditure. The central banks control the foreign exchange and currency reserves which are crucial in maintaining a stable currency exchange rate in the international foreign exchange market. The central bank is engaged in the development of sound financial system like effective payment system and promoting macroeconomic objectives which are geared at maintaining low inflation and ensuring high economic growth. The central bank is the lender of the last resort for commercial banks which can not access credit from any other source and it does this through the discount lending window or overnight lending. The central bank acts as clearing house for mutual settlement of obligations among commercial banks and also uses the monetary policies to create sound economic and financial environment in the economy (Makinen & Labonte, 2006).
The monetary policy which is administered by the Federal Reserve is aimed at controlling the level of inflation, promoting higher economic growth and creating employment in the economy. The monetary policy in the US uses three main tools which are open market operations, discount rate and foreign currency operations. Open market operations involves selling and buying of treasury bills in the market in order to decrease and increase money supply in the economy respectively. When the Federal Reserve wants to control high inflation it will sell treasury bills in the market which mop up excess credit and it will it will buy the treasury bills from the public in order to increase the money supply in the banking system which lowers the levels of market interest rates hence leading to more investments and high employment. To reduce the level of money supply, the Federal Reserve can also increase the discount rate which is the rate at which commercial banks borrow from the Federal Reserve which will make the commercial banks also increase their lending rates thus discouraging credit creation.