More Important Feature of Money: Medium of Exchange, or Unit of Account?

by Kurt Schuler

Scott Sumner and Nick Rowe have been having a friendly debate about which is the more essential function of money: medium of exchange (Rowe) or unit of account (Sumner). I think they are missing an important point: the combination of the three textbook functions of money — medium of exchange, unit of account, and store of value — in one good makes it far more powerful and significant than if the functions are separated.

When the functions are separated, attempts to influence the economy through monetary policy can lose much of their effect. Here’s an example. When I visited Peru in 1999, I noticed an advertising circular in a local newspaper for Ace Hardware. The prices were in U.S. dollars, not Peruvian soles. I asked my hosts about it and they said that at the cash register, customers paid in soles at the exchange rate of the day against the dollar. And this was after Peru had enjoyed five years of inflation at 15 percent or lower. People were still cautious because in the 1980s inflation been very high, peaking at above 7,000 percent in 1990. Even goods priced in soles might in practice be closely indexed to the dollar.

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image: flickr.com/rapidtravelchai

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