WHAT IS (NOT) MONEY?

MEDIUM OE EXCHANGE + MEANS OF PAYMENT

by Bill Z. Yang*
Abstract
This note attempts to provide a formulaic defmition of money and discuss the distinction between
"medium of exchange" and "means of payment." The former refers to the set of assets in an economy
that people regularly exchange 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 "how"). It suggests that money should
be exclusively defined as "medium of exchange," rather than "means 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 medium of exchange as "anything
that is generally accepted as payment for goods and
services or in the settlement of debts" (Hubbard,
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 just learnt that "money is anything
that is generally accepted as payment." The stan-
dard argument in most textbooks is that "check is
not money but the checking deposits are" without
explaining why a check is not money. Mumbles
from students would often be "A check is indeed
generally accepted as payment, by definition, why
isn't it money? If a check is not money, then what is
it?" To our knowledge, no textbook has directly
answered these questions. Therefore, it is necessary
to define money correctly so that one can easily
judge whether a commonly-used "means of pay-
ment" is money, by deflnition.
This note is intended to provide such a formula-
ic definition of money. We define money as medi-
um of exchangethe set of assets in an economy
that people regularly exchange for goods and
services from others. There are two key points in
this definition. First, money must be an asset that
signifies a part of what its holder owns. Second,
people normally convert their assets from other
forms to this specific one before exchanging for
goods and services, implying that this set of assets
are generally accepted in transactions. By defini-
tion, currency and demand deposits are money,
while checks, credit and debit cards are not. This is
because currency and checking deposits are their
owner's assets, whereas a check or a credit/debit
card is not a part of its owner's assets.
Then, what is check if it is not money? Why is it
"generally accepted in transactions?" ChecJcs as
well as debit cards, credit cards and money orders,
etc., are a means of payment, referred to as a gen-
erally accepted (institutional) arrangement or
method that facilitates delivery of money from
one to another. For example, a (signed) check
essentially serves as a "standardized permit" that
authorizes the recipient to claim a certain amount of
checkable deposits from the check writer's bank
account, but the check itself does not signify any
part of the writer's assets. That is, a check is a
means of payment and hence generally accepted in
transactions, though it is not a medium of exchange.
Conceptually, medium of exchange should NOT
be used as a synonym of means of payment; the
medium of exchange stands for "what" (is paid)
School of Economic Development, Georgia Southem University, Statesboro, GA 30460-8152, E-mail:
billyang@georgiasouthern.edu. The author would like to thank an anonymous editor for helpful com-
ments.
Vol. 51, No. 2 (Fall 2007) 101
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 because 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. Interpretations 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 payment and "gener-
ally accepted as payment." But they were immedi-
ately told that a check is not money! Confused? Of
course! 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 exchange
for what she wants to buy. A medium of exchange
has two key features: First, it represents a part of its
owner's assets; second, it is commonly accepted in
transactions. We refer to medium of exchange as
the set of assets in an economy that people regu-
larly exchange for goods and services.^
In a modern payment system, an exchange
process essentially takes two steps. At step 1, poten-
tial buyers allocate a part of their assets in the form
of, or directly exchange their goods or services for,
a specific type of assets that is ready to make pay-
ment. For example, when one works and gets paid
she actually trades her labor service for bank
deposits or currency. At step 2, buyers exchange
their bank deposits or currency for goods and ser-
vices from sellers. Clearly, checkable deposits and
currency are a part of people's assets and serve as a
medium of exchange in transactions. By definition,
checkable deposits and currency are money.
A related question is: How do buyers deliver
money to sellers? In other words, how to make pay-
ment? In the real world, people have gradually
developed a variety of means of paymentgener-
ally accepted institutional arrangements or
methods that facilitate delivery of money from
one to another. For example, a buyer may with-
draw currency from her bank account or ATM and
then hand-to-hand deliver it to make payment. In
this case, currency also serves as the ultimate means
of payment; when cash changes hands, payment is
made and exchange is completed.
To deliver cash hand to hand is not the only
means of payment, however. Writing checks is
another very popular method to make payment.
Unlike cash, a signed check itself does not carry
any value of the check writer. In fact, it only plays
a role of a standardized permit that authorizes the
recipient to claim a certain amount of checkable
deposits from the check writer's bank account. As a
signed check changes hands, payment is not really
completed until the recipient has finally received
Assets
(Medium of exchange)
Money
Buyer
Seller
Goods or services
FIGURE 1. Money as medium of exchange
102 THE AMERICAN ECONOMIST
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 medium of exchange conveys a part
of one's assets ready to be traded for goods 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, medium of
exchange is a concept of "what is to be paid", while
means of payment is a notion of "how to deliver it."
Hence, "medium of exchange" and "means of
payment" are NOT synonymous. 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 exchangethe 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, because 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 to
a "standardized permit." What about other non-
money means of payment? Since debit cards and e-
checks are just electronic version of checks, they
can be interpreted as e-permit. Similarly, money
order, cashier's check and traveler's check essen-
tially serve as "standardized receipts." Their issuer
plays a role of "general cashier," working for all
recipients. For example, when one buys a money
order from post office with cash, the money is paid
to this "cashier" (the post office), while the money
order is the receipt with which the recipient will
claim the payment from the issuer later.
Table 1 lists some often-used means of payment
and their functions.
4. Conclusion
This note is intended to provide a correct and
formulaic definition of money; with it that one can
easily determine what is money and what is not
money. We emphasize two points: First, medium of
exchange and means of payment are not synony-
mous; medium of exchange is the set of assets in an
economy that people regularly exchange for goods
or services, while a means of payment is a general-
ly accepted institutional arrangement or method
that facilitates delivery of money from one to anoth-
er. Second, money should be exclusively defined as
medium of exchange but not means of payment or
"anything that is generally accepted as payment."
With such a distincdon established, one can explain
consistently whether or not a specific means of pay-
ment is money and why. It may help to better
understand the concept of money in economics and
avoid unnecessary confusions caused by the con-
ventional but incorrect definitions of money.
Money
Checking deposits
Assets
Buyer O j e ^ (_.Pniii) ^
<
Goods or services
FIGURE 2. Check as a means of payment but not a medium of exchange.
Seller
Vol. 51, No. 2 (Fall 2007) 103
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
No
No
No
No
No
No
No
Yes
Yes
Yes
Yes
No
No
No
No
No
No
No
Footnotes
1. Similar interpretations for medium of exchange
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. Money has three (or four) functions: Medium
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 example, see Hubbard (2004, p. 14),
Mishkin (2004, p. 44), Thomas (2006, p. 19),
and Burton and Lombra (2005, p. 24), among
others.
4. For example, see Burton and Lombra (2006, p.
24), Miller and VanHoose (2004, p.6), and Bau-
mol and Blinder (1999, p. 626), among others.
5. Our definition for money is very close to
Mankiw's (2003, p. 220): "Money 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 similar definition. We replace "use [it] to
buy" by "exchange [it] for" to emphasize 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 judge whether a means of
payment carries value is whether you can have
your "money" back with an institutional
arrangement through the payment system, if
you happen to lose it.
References
Baumol, William J., and Alan S. Blinder, 1999.
Economics: Principles and Policy, 8th Edition,
Dry den.
Bade, Robin, and Michael Parkin, 2002. Founda-
tions of Macroeconomics, Addison Wesley.
Burton, and Lombra, 2006. The Financial System
and the Economy: Principles of Money and
Banking, 4th Edition, Thomson South-Western
Frank, Robert H. and Ben S. Bemanke, 2004. Prin-
ciples of Economics, 2nd Edition, Irwin McGraw
Hill.
Hubbard, Glenn, 2004. Money, the Financial Sys-
tem, and the Economy, 5th Edition, Pearson
Addison Wesley.
Mankiw, N. Gregory, 2004. Brief Principles of
Macroeconomics, 3rd Edition, Thomson South-
Westem.
Mishkin, Frederic S., 2004. The Economics of
Money, Banking, and Financial Markets, 7th
Edition, Pearson Addison Wesley.
Shiller, Robert, 2003. The New Financial Order,
Princeton: Princeton University Press.
Thomas, Lloyd B., 2006. Money, Banking and
Financial Markets, Thomson South-Wester.
104 THE AMERICAN ECONOMIST