The monetary system refers to a set of institutions that provides a supportive framework for the creation of money in an economy by the government.
There are 3 types of monetary system:
- Commodity money
- Commodity-based money
- Fiat money
The most common type of monetary system is Fiat money.
In this article, the various types of monetary systems are discussed along with important terms related to money which holds relevance for the IAS Exam.
Monetary System (UPSC Notes):- Download PDF Here
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Types of Monetary system
The types of the monetary system are discussed below:
Commodity Money
Commodity money is the type of money that is made of precious metals or commodities that have intrinsic value. It is not just a token or representative of monetary value like banknotes. Its worth remains intact even after it is melted. Gold and silver coins are the perfect example of commodity money.
Commodity-based money
This type of monetary system can also be addressed as representative money. This type of currencies are mostly like physical bank-notes with no financial value but can be exchanged with precious metals like gold and silver. This is closely related to the term gold standard.
Fiat Money
This type of money is also termed as legal tender as notified by the Central Government and Central Bank. This is unlike the commodity money; it might not have an intrinsic value. Paper currencies and metal coins are examples of fiat money.
In modern economies or current phase, it mainly exists as data such as bank balances and records of credit or debit card purchases.
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Important terms related to Money
Money – Anything which has general acceptance as a means of payment.
Functions of Money
Medium of Exchange
- Common measure of value
- Standard for deferred payments
- Store of wealth
Barter System – A commodity is exchanged for other commodities.
- Problems of barter System are:-
- Double coincidence of what is required
- Valuation of commodities exchanged is a problem
- There won’t be a standard to serve as future monetary obligations
Gresham’s Law – Bad money drives out good money
Legal Tender Money – This money cannot be denied in the settlement of the monetary obligation
- Limited Legal Tender Money: It is compulsory to accept up to a certain limit
Example – A sum of 10 can be paid in denominations of 50 paisa coins and the recipient has to legally accept it.
- Unlimited Legal Tender Money: This money can be used to make any amount of payment
Non-Legal Tender Money – There is no legal compulsion to accept this money. It is also called optional money or Fiduciary Money (on the basis of trust).
- E.g. – Nepalese currency at India – Nepal border may be used as but the recipient is not legally bound to accept it.
Near Money – Highly liquid financial assets like shares and bonds
For similar notes on important Economy topics, check the linked article.
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FAQs
Different 4 types of money
Fiat money – the notes and coins backed by a government. Commodity money – a good that has an agreed value. Fiduciary money – money that takes its value from a trust or promise of payment. Commercial bank money – credit and loans used in the banking system.
What are the 4 types of money? ›
Different 4 types of money
Fiat money – the notes and coins backed by a government. Commodity money – a good that has an agreed value. Fiduciary money – money that takes its value from a trust or promise of payment. Commercial bank money – credit and loans used in the banking system.
What are the four monetary systems? ›
The four major types of international monetary regime are specie standard, managed fixed exchange rate, free float, and managed float. They differ in their solution, so to speak, of the impossible trinity.
What is the difference between commodity money commodity based money and fiat money? ›
Commodity money has intrinsic value because it has other uses besides being a medium of exchange. Fiat money serves only as a medium of exchange, because its use as such is authorized by the government; it has no intrinsic value.
What are the 4 functions of money? ›
The four main functions of money include: acting as a standard of deferred payment, being used as a store of value, acting as a medium of exchange, and being used as a unit of account.
What are the categories of money? ›
There are four categories of money. They are fiat money, commodity money, fiduciary money, and commercial bank money.
What are the 5 things of money? ›
The basic truth is that we can do five things with our money: (1) save it; (2) spend it; (3) give it away; (4) pay taxes; and (5) pay down debt. Shake it up any way you want, and chances are it will end up in one of those buckets.
How many types of monetary are there? ›
Economists differentiate among three different types of money: commodity money, fiat money, and bank money. Commodity money is a good whose value serves as the value of money. Gold coins are an example of commodity money. In most countries, commodity money has been replaced with fiat money.
What are the 4 main components in the international monetary structure? ›
It consists of four elements: exchange arrangements and exchange rates; international payments and transfers relating to current international transactions; international capital movements; and international reserves.
What is the basic monetary system? ›
A monetary system is a system by which a government provides money in a country's economy. Modern monetary systems usually consist of the national treasury, the mint, the central banks and commercial banks.
Commodity money has been used throughout history as a medium of economic exchange. Commodity money is money that has intrinsic value, meaning that it has value even if it is not used as money. Examples of commodity money include precious metals, foodstuffs, and even cigarettes.
Are coins fiat money or commodity money? ›
In contrast to commodity-based money, such as gold coins or paper bills redeemable for precious metals, fiat money is backed entirely by the full faith and trust in the government that issued it. One reason this has merit is that governments demand that you pay taxes in the fiat money it issues.
Is Bitcoin fiat money or commodity? ›
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. Is Bitcoin a commodity? Yes, virtual currencies, such as Bitcoin, have been determined to be commodities under the Commodity Exchange Act (CEA).
What is an example of commodity money? ›
Commodity money is money that has intrinsic value, meaning that it has value even if it is not used as money. Examples of commodity money include precious metals, foodstuffs, and even cigarettes.
What are the three basic functions of money? ›
To summarize, money has taken many forms through the ages, but money consistently has three functions: store of value, unit of account, and medium of exchange. Modern economies use fiat money-money that is neither a commodity nor represented or "backed" by a commodity.
What are the 3 types of money? ›
What is money? Money is any good that is widely used and accepted in transactions involving the transfer of goods and services from one person to another. Economists differentiate among three different types of money: commodity money, fiat money, and bank money.
What are the 7 types of paper money? ›
Paper money
American paper currency comes in seven denominations: $1, $2, $5, $10, $20, $50, and $100. The United States no longer issues bills in larger denominations, such as $500, $1,000, $5,000, and $10,000 bills. But they are still legal tender and may still be in circulation.
What is the oldest money? ›
The shekel was the unit of weight and currency, first recorded c. 2150 BC, which was nominally equivalent to a specific weight of barley that was the preexisting and parallel form of currency.
What are the modern forms of money? ›
Modern forms of money include currency-paper notes and coins. Unlike the things that were used as money earlier, modern currency is not made of precious metal such as gold silver and copper. And unlike grain and cattle, they are neither of everyday use.
What are the 3 types of money can you provide an example of each? ›
Economists differentiate among three different types of money: commodity money, fiat money, and bank money. Commodity money is a good whose value serves as the value of money. Gold coins are an example of commodity money. In most countries, commodity money has been replaced with fiat money.
