By Michael D. Bordo, Barry Eichengreen
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Additional resources for A Retrospective on the Bretton Woods system
Secondly, it is absolutely not necessary, and it is even harmful, to create money. Indeed, creating money means creating nominal cash balances; but we have seen that there are certainly less real cash balances whenever there are more nominal cash balances. If one refrains from creating nominal cash balances and there is an increase in the demand for real cash balances because of the growth of production and trade, individuals become demanders of cash balances and suppliers of commodities in return, so that the price of the currency in terms of goods and services increases: that is, the monetary price of goods and services decreases (deflation).
It is obvious that such searches are costly, at least in terms of time. Information on the relative prices in markets is difficult to obtain and to keep in mind, since in a universe with n goods, one needs to know the relative prices between a commodity and each of the n − 1 other ones. Thus, there is a very large number of prices. 26 The demand for money 27 Information costs are considerably reduced if there is a good with monetary characteristics. It can be one of the n existing goods – which is then desired both for its own characteristics and for its monetary nature – or any other good which has only a monetary role.
In very simple terms a good monetary system is a system which allows individuals to have ‘sound money’. But what is a ‘sound currency’? This is obviously a currency that fulfils its role (or roles). Analysing the roles of a currency and the reasons for which it is desired is therefore a necessary step in the analysis of monetary systems. The latter follows logically from the study of the functions of a currency. 1 THE ROLES OF MONEY Money plays two key roles and it is precisely because it plays both these roles that, probably, it was invented, although its appearance cannot be dated: money makes indirect exchange possible, and it facilitates exchanges over time.