3.8: The Characteristics and Supply of Money

Money Characteristics

If you happen to have one on you, take a look at a $5 bill. Though this piece of paper — indeed, money itself — has no intrinsic value, it is certainly in demand. Why? Because money serves three basic functions:

• a medium of exchange;
• a measure of value; and
• a store of value.

To get a better idea of the role of money in a modern economy, let us imagine a system in which there is no money. In this system, goods and services are bartered — traded directly for one another. Now, if you are living and trading under such a system, for each barter exchange that you make, you will have to have something that another trader wants. For example, say you are a farmer who needs help clearing his fields. Because you have plenty of food, you might enter into a barter transaction with a labourer who has time to clear fields but not enough food: he’ll clear your fields in return for three square meals a day. This system will work as long as two people have exchangeable assets, but needless to say, it can be inefficient. If we identify the functions of money, we will see how it improves the exchange for all the parties in our hypothetical set of transactions.

Money is anything that is acceptable as payment for goods and services. It affects our lives in many ways. We earn it, spend it, save it, invest it — and often wish we had more of it. Businesses and the government use money in similar ways. Both require money to finance their operations. By controlling the amount of money in circulation, the federal government can promote economic growth and stability. For this reason, money has been called the lubricant of the machinery that drives our economic system. Our banking system was developed to ease the handling of money.

Medium of Exchange

Money serves as a medium of exchange because people will accept it in exchange for goods and services. Because people can use money to buy the goods and services that they want, everyone’s willing to trade something for money. The labourer will take money to clear your fields because he can use it to buy food. You’ll take money as payment for his food because you can use it not only to pay him but also to buy something else you need (perhaps seeds for planting crops).

For money to be used in this way, it must possess a few crucial properties:

• It must be divisible — easily divided into usable quantities or fractions. A $5 bill, for example, is equal to five $1 coins. If something costs $3, you don’t have to rip up a $5 bill; you can pay with three $1 coins.
• It must be portable — easy to carry; it can’t be too heavy or bulky.
• It must be durable — strong enough to resist tearing, and the print can’t wash off if it winds up in the washing machine.
• It must be difficult to counterfeit — it won’t have much value if people can make their own.

Measure of Value

Money simplifies exchanges because it serves as a measure of value. We state the price of a good or service in monetary units so that potential exchange partners know exactly how much value we want in return for it. This practice is a lot better than bartering because it’s much more precise than an ad hoc agreement that a day’s work in the field has the same value as three meals.

Store of Value

Money serves as a store of value. Because people are confident that money keeps its value over time, they’re willing to save it for future exchanges. Under a bartering arrangement, the labourer earned three meals a day in exchange for his work. But what if, on a given day, he skipped a meal? Could he “save” that meal for another day? Maybe, but if he were paid in money, he could decide whether to spend it on food each day or save some of it for the future. If he wanted to collect his unpaid meal two or three days later, the farmer might not be able to pay it; unlike money, food could go bad.

The Money Supply

Now that we know what money does, let us tackle another question: how much money is there? How would you go about “counting” all the money held by individuals, businesses, and government agencies in this country? You could start by counting the money that’s held to pay for things on a daily basis. This category includes cash (paper bills and coins) and funds held in demand deposits — chequing accounts, which pay given sums to “payees” when they demand them.

Then, you might count the money that is being “saved” for future use. This category includes interest-bearing accounts, time deposits (such as certificates of deposit, which pay interest after a designated period of time), and money market mutual funds, which pay interest to investors who pool funds to make short-term loans to businesses and the government.

M-1 and M-2

Counting all this money would be a daunting task (in fact, it would be impossible). Fortunately, there’s an easier way — namely, by examining two measures that the government compiles for the purpose of tracking the money supply: M-1 and M-2.

• M-1 is the narrowest measure, and it includes the most liquid forms of money — the forms, such as cash and chequing account funds, which are spent immediately.
• M-2 includes everything in M-1 plus near-cash items invested for the short term — savings accounts, time deposits and money market mutual funds.

How much money is out there? As of March 2025, the M1 money supply in Canada was approximately 1,641,346 million CAD  ^[1] In 2025, M-2 in Canada increased to CAD 2,695,496 million in March from CAD 2,689,800 million in February.^[2]

What Exactly Is “Plastic Money”?

Are credit cards a form of money? If not, why do we call it plastic money? Actually, when you buy something with a credit card, you are not spending money. The principle of the credit card is buy-now-pay-later. In other words, when you use plastic, you are taking out a loan that you intend to pay off when you get your bill. And the loan itself is not money. Why not? Basically, because the credit card company cannot use the asset to buy anything. The loan is merely a promise of repayment. The asset does not become money until the bill is paid (with interest). That is why credit cards are not included in the calculation of M-1 and M-2.

The Role of the Bank of Canada

The Bank of Canada is the nation’s central bank. Its principal role is “to promote the economic and financial welfare of Canada,” as defined in the Bank of Canada Act. The Bank of Canada is a special type of Crown corporation that is owned by the federal government but has considerable independence to carry out its responsibilities and therefore operates separately from the political process.

The Bank’s four main areas of responsibility are:^[3]

• Monetary policy: The Bank influences the supply of money circulating in the economy, using its monetary policy framework to keep inflation low and stable.
• Financial systems: The Bank promotes safe, sound and efficient financial systems, within Canada and internationally, and conducts transactions in financial markets in support of these objectives.
• Currency: The Bank designs, issues and distributes Canada’s bank notes.
• Funds management: The Bank is the fiscal agent for the Government of Canada, managing its public debt programs and foreign exchange reserves.

The Bank of Canada is led by the Governing Council, the policy-making body of the Bank, which is responsible for:

• conducting monetary policy; and
• promoting a safe and efficient financial system.

The Governing Council is made up of the Governor, the Senior Deputy Governor and the Deputy Governors. The Governing Council’s main tool for conducting monetary policy is the target for the overnight rate (also known as the key policy rate). This rate is normally set on eight fixed announcement dates per year. The Council reaches its decisions about the rate by consensus, rather than by individual votes, as is the case at some other central banks.

The Bank of Canada plays a vital role in managing the country’s money supply. If the Bank of Canada wants to increase the money supply, it can buy government securities. The individuals and investors who sell these bonds then deposit the proceeds in their banks. These deposits increase banks’ reserves and their willingness to make loans. The Bank of Canada can also lower the bank rate; this action will cause increased demand for loans from businesses and households because these customers borrow more money when interest rates drop.

If the Bank of Canada wants to decrease the money supply, it can sell government securities. Individuals and investors spend money to buy bonds, and these withdrawals bring down banks’ reserves and reduce their willingness to make loans. The Bank of Canada can also raise the bank rate; this action will decrease the demand for loans from businesses and households because these customers borrow less money when interest rates rise.

Media Attributions

“Silver, Cat, Animal image” by Allange, used under the Pixabay license.

“Credit cards, Denim, Jeans image” by TheDigitalWay, used under the Pixabay license.