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I'm aware of the following four functions of money:

  1. Medium of exchange.
  2. Measure of value (in dollars, pounds, etc.)
  3. Standard for exchanging goods (guaranteed by the Fed)
  4. A Store of value (as an asset).

AFAIK, the last one didn't exist according to Classical Economists, but only John Maynard Keynes brought it later in his theory.

I want to understand whether this function really exists? I'm more inclined to agree with the Classical Economists -

I've created a simple analogy to understand this. Suppose there is a small village where there are N residents who trade only in barter. Now, you introduce a new bank in the village called Banko and a currency called pebbles. (For simplicity, lets assume that Banko is both a central bank and also lends/borrows money).

Now in order to leave barter and migrate to currency system, the villagers will have to either sell their goods to Banko, or borrow pebbles from them. So, there is a "give and take" or exchange of pebbles against goods.

But at the end of the day, if you consider the overall macro-economic position, the pebbles made no difference in value at all. The villager's NET ENDOWMENT is same as it was before, the pebbles just facilitate transactions and used to count their assets now.

So, my question is, if money doesn't make any difference to the REAL value of goods and services, how can it be considered an asset?

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You should define what you mean by "net worth." In a lot of ways, the statement that "the villager's NET WORTH is same as it was before" is not correct. In the jargon of economics, we might say that the total endowment of the island economy is unchanged, but the "value" that you speak of---if our analysis is to be useful---is probably something different than the physical endowment of goods. Try to define "value" and this question will be a lot easier to answer. –  jmbejara Feb 10 at 9:46
    
Try to define "value" and this question will be a lot easier to answer. - Yup, value here means total endowment of goods and services in an Economy. Hence, the word "REAL" as in REAL output. It remains the same even after the introduction of money. –  Prahlad Yeri Feb 10 at 10:25
    
"Worth"/"value" and "endowment" are very different things. If endowment if what you're concerned with, this question is almost trivial (and less interesting). I say almost, because you could argue that money can have an effect on production. If money can facilitate trade, it's reasonable to think that that facilitated trade could allocate capital more efficiently---and thus increase production which would leave the island with more physical "stuff." –  jmbejara Feb 10 at 10:31
    
>>"Worth"/"value" and "endowment" are very different things. - In a lot of ways they are correlated. If you have read about Say's Law of markets (J.B Say), Say equates the endowment with value, hence the deduction that Full Employment will always exist as long as each and every endowment is fully employed (provided Lassez Faire exists of course, the primary assumption of Classical Economics). –  Prahlad Yeri Feb 10 at 10:36
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From your comments and the changes to the question, I think it's no longer clear what you are asking; indeed, you seem to be asking about several different things at the same time. –  EnergyNumbers Feb 10 at 10:40

6 Answers 6

What is value? Ultimately, value flows from the utility people get from consuming goods and services.

Now, suppose, in your example world, I am a farmer and it is Autumn so I have the product of a large harvest. Here are three things I could do with it:

  • Consume (and thereby enjoy the value of) my entire harvest immediately. But this would leave me hungry in the winter.
  • Store some food for later: Put some of the grain I produced into a silo and take it out of the silo to eat in the winter.
  • Sell some of my food to the bank in return for pebbles. Then, later in the winter, use those pebbles to buy back some food when my supply has run out.

Notice that points 2 and 3 are essentially equivalent (they result in the same distribution of consumption across time). In the former, I am directly storing food. In the latter, I am using the pebbles to store the value associated with the food until I want to claim that value back.

Although the store of value is really just an abstract implementation of the physical storage of the goods generating that value, this distinction becomes important in more sophisticated economies. Storing value rather than storing the goods that generate that value is attractive for a few reasons.

  1. Many goods and services are hard to store. For example, as an economics professor it is impossible for me to "store" lectures during the autumn for use in the summer when I can't find any students to teach. How do I avoid starving during these long, studentless summer months? I take the (hopefully positive) value my lectures produce during the autumn and store this value in money. I can then claim this value back during the summer when I need it.

  2. Storage of physical stuff takes up a lot of space and is expensive. Storage of money is much less so. Similarly, transporting stuff is expensive. With a bank card it becomes unnecessary to transport money at all.

  3. Storage is often wasteful because it involves stuff sitting around doing nothing when it could be generating utility for someone.

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>>Storing value rather than storing the goods that generate that value is attractive for a few reasons. - Yup, it is. But whether that value can actually be considered as an economic asset is a subjective thing. btw, thanks for such lucid explanation. I'm honored to get an answer by an actual Professor! –  Prahlad Yeri Feb 10 at 12:36
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Good explanation. Just to note, this is essentially the same argument as has been made before. Instead of facilitating trades across space, here we are facilitating trade across time. Hopefully @Ubiquitious' answer here satisfies your question. His first point is I think an important one. Value is derived from (subjective) utility. –  jmbejara Feb 10 at 12:54

This is similar to what has already been said and it depends on what you classify as an asset. Money, although intrinsically worthless, maintains some worth which allows you to purchase in the future.

There are three papers that I found really interesting on the subject (and I don't remember them being overly technical). They are three Kiyotaki Wright papers (1989, 1991, 1993).

These papers basically set up a very simple economy (the one I'm thinking of has n goods and n agents). They then show what trade would look like in these economies without money and then what it would look like with the money. And one of the papers gets people basically establishing money (by saving a certain type of good which everyone accepts in trade). The others show that if you insert money into the economy then you are better off.

Also, worth looking into if this is interesting to you is Neil Wallace's idea of "essentiality of money."

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>> The others show that if you insert money into the economy then you are better off. - Again, that depends on what you call "being better off". If you consider the sum total of all goods and services, what difference has money made? Their value remains the same as w/o money. They are better off only because it is a medium of exchange or a facilitator for transactions. –  Prahlad Yeri Feb 10 at 5:21
    
"depends on what you call 'being better off'" This goes without saying. The most reasonable way of thinking about it is in terms of utility---which is what they do. ---On the other hand... "Their value remains the same as w/o money." If I wanted to nit-pick, I would say that it depends on what you mean by "value." Under some reasonable definitions of "value", your statement "their value remains the same as w/o money" would certainly not be true. –  jmbejara Feb 10 at 8:05
    
cc7768's answer here is good because it cites some important academic papers. The cited authors have contributed important theory to describing the role of money. For example, see Randall Wright's wikipedia page. It has a short description of some of his contributions in this area. en.wikipedia.org/wiki/Randall_Wright –  jmbejara Feb 10 at 10:38
    
Like @jmbejara mentioned, I defined better off in terms of welfare which I believe they just use total utility. I believe that the total utility is a better measure of how well off the people are than measuring goods and services because utility actually measures individuals "happiness." I could have been more explicit about this. –  cc7768 Feb 10 at 12:22

"Store of value" is part of the definition of money. That is to say, it's not really meaningful to ask "is money a store of value", because if it wasn't a store of value, it wouldn't be money.

If a purported currency can't be exchanged for assets next week, next month, in a very similar manner to how it can be exchanged today, then it's not money. No one can trust it enough to accept it in exchange for goods and services. It doesn't have the option value of: consume now versus consume later.

Your analogy confuses wealth with money. They overlap, but are not identical. In your example, the bank has no wealth unless people accept that trade must occur with pebbles: in that case, the bank is indeed wealthy, because it has all the pebbles, and everyone else has to give up something in order to access the pebbles.

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>> "in that case, the bank is indeed wealthy, because it has all the pebbles" - Of course it is. Central Bank in every country has that power. The Fed can print as many bills as it wants and command all wealth of its citizens (in theory). But did it make any REAL difference to the overall economy? No. Did the total value of goods in the economy increase just by introducing money? No. I'm looking from that perspective. –  Prahlad Yeri Feb 10 at 9:08
    
@PrahladYeri but that's not what your question title asks. You asked about store of value, not whether it improved overall economic efficiency. Which, incidentally, it does as well. –  EnergyNumbers Feb 10 at 10:39
    
Both things are correlated! If you agree that money doesn't have a value store (and thus disagree with Keynes), it is implied that it cannot improve overall economic efficiency (because in that case, what remains of it is only a transaction facilitator or a state-approved piece of paper). –  Prahlad Yeri Feb 10 at 10:45

Money, as a store of value, can affect macroeconomic allocations.

The classical reference is Samuelson 1958 (google for the paper if you don't have access to it).

In your example, all the traders meet at the marketplace at once and exchange goods. In this case, you are right to say that although money makes trading more convenient, it does not affect the end allocations (as long as people have the time and patience necessary).

Samuelson consider a different setup, where all agents cannot meet in the same marketplace at once, because some of them are not born yet. A simplified version of his model looks as follows:

  • Time is infinite and discrete, $t=0,1,2,\ldots$.
  • In each period $t$, a generation $t$ consisting of $1$ person is born. A generation lives in two periods (so generation $t$ lives in periods $t$ and $t+1$. People are born without any assets.
  • In period $0$, there already exists a generation $-1$ of old people. They have nothing.
  • People work when they are young, and produce $1$ apple. When they are old, they cannot produce anything. Apples rot if they are not eaten the same day they are produced (they are not storable).
  • People get utility $u(c^y)+u(c^o)$ if they consume $c^y$ apples when they are young and $c^o$ apples when they are old. $u$ is concave, for concreteness, let $u(c) = \sqrt{x}$.
  • In each period, people can trade with each other.

In this model, the following will happen: In time $0$, generation $0$ will produce $1$ apple. Since generation $-1$ has nothing to offer them, no trade will occur and generation $0$ will consume the apple themselves. In time $1$, generation $1$ will produce $1$ apple. Since generation $0$ has nothing to offer generation $1$, generation $1$ will consume the apple themselves. And so on. Every generation will consume $1$ apple when young and $0$ apples when old (except generation $-1$ who will consume $0$ apples when old but will not exist when young). The utility of each generation will be $u(1)+u(0)=1$.

Now consider what happens if the initial old have a piece of paper that we call money. Let us say that the piece of paper is considered to be worth $0.5$ apples. What will people do?

The initial old will obviously swap their piece of paper for $0.5$ apples (they are about to die and have no reason to die with a piece of paper in their hands instead of apples in their bellies). Will the young accept the trade? They have one apple today, but no income tomorrow. Since their utility is concave, they would prefer to consume a little bit today and a little bit tomorrow rather than all at once today. Therefore, they accept the trade, and give up $0.5$ apples today for the piece of paper, with the expectations of being able to swap the paper tomorrow for apples tomorrow. In period $1$, the old will happily swap their piece of paper for $0.5$ apples, and the young will accept the trade for the exact same reason as the young of period $0$ accepted the trade. Every generation will consume $0.5$ apples when young and $0.5$ apples when old (except generation $-1$ who will consume $0.5$ apples when old, and not exist young). The utility of each generation is $\sqrt{0.5}+\sqrt{0.5} = \sqrt{2}>1$.

The introduction of "the social contrivance of money" affected macroeconomic outcomes, and in fact made everyone better of. Note that we can equally well call the worthless paper in this model "government bond" or a pay-as-you-go retirement scheme promise.

This little exposition is informal, and I definitely cut a bunch of corners. Read the paper, or any good textbook exposition of overlapping generation models (OLG).

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Thanks for the lucid explanation! Though, a neo-classical might argue that your generational model will hold equally good in a barter-economy with no money. Consider having a non-perishable commodity such as pebbles instead of paper in this model. Even in that case, the older generation will sacrifice their apples for pebbles. Only, pebbles are more intrinsically useful as a currency than paper or bonds. –  Prahlad Yeri Feb 11 at 2:42

Money can be seen as a store of value in your thought experiment and in reality. If you have many pebbles, you can choose to keep those pebbles where convenient in lieu of having other assets. Money is an asset where it can be readily be exchanged for other, more tangible assets.

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Yeah, you can choose to keep pebbles for convenience sake, but then it became an asset only for you (personally). If you take the sum total of the over-all Economy, the value of all goods and services is still the same as it would be without pebbles! –  Prahlad Yeri Feb 10 at 3:54
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Ah, I see your point. One of the other factors about fiat money is that it is intrinsically worthless. That's ok wrt our understanding of an asset. Cash can be exchanged for something of value, that makes it an Asset. –  Jamzy Feb 10 at 4:07

The villager's NET WORTH is same as it was before

Before they had money, they didn't have a net worth. What would the worth be denominated in? They had an inventory of assets, but if they're bartered in an adhoc fashion it's not sensible to compute a net worth figure. If they're bartered in a highly consistent fashion against some common article of trade (e.g. knives), such that you can calculate an asset value, then it's not much of a stretch to call that article money, such as the "knife money" in historical China.

We can see the reverse of this in the real economy. Fluctuating house prices cause the total value of the housing stock to move up and down, without the stock itself changing.

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