Question

What are the three basic functions of money? Describe how rapid inflation can undermine money’s ability to perform each of the three functions.

Answer each part of the question, and give details.

What "backs" the money supply in the United States? What determines the value (domestic purchasing power) of money? How does the purchasing power of money relate to the price level? Who is the U.S. is responsible for maintaining money 's purchasing power?

Answer 1

1. Money is often defined in terms of the three functions or services that it provides. Money serves as a medium of exchange, as a store of value, and as a unit of account. Conceptually, inflation would not affect the function of money as a medium of exchange unless the inflation was sudden, omnipresent, and severe in which case, we could choose to base our exchange on something that we could more easily value like the property or labor of each other (i.e. barter). But as a medium of exchange, generally speaking, we either agree to accept the money of each other or we do not. If we do, then even with some moderate inflation, the function of money as a medium of exchange remains intact. Yet inflation will have an impact as a store of value. Inflation decreases buying power to the degree that costs change faster than "sticky" incomes Excessive and widespread deflation, by increasing purchasing power, reduces living standards in an economy. It also reduces the future savings value to the extent that prices move faster than savings can yield. That's why it is so important to invest and get an acceptable rate of return. During your lifetime, your investments need to produce more than the rate of inflation.

2. Nothing supports our money supply. There was a time when paper money could be turned into government for gold coins, but that practice ended in 1934 when Congress changed the Federal Reserve Act's wording. In the 1960s, the tradition of turning our paper money into silver coins stopped. In fact, our supply of money is supported by a conviction that our money is worth something.
If people lose faith in the value of our money, in exchange for goods and services people will stop accepting it. People believe, however, that our money is worth something and that the government is taking action to ensure that this belief continues to exist.

There is a connection between buying power and the price of goods. As product prices decrease, purchasing power increases. If prices are lower, with the money they have, people can buy more things. This is known as a period of deflation if there is a prolonged period of lower prices. Consumers tend to like a situation where, by being able to buy more products, their money goes further. On the other hand, purchasing power decreases as prices rise. With their money, people can buy less goods. Inflation is defined as an extended period of time of rising prices. Inflation makes buying items more difficult for people because they need more money to buy the things they need. People in debt tend to benefit from an inflationary period because they can spend less of the money they use to repay their debt than when they received their loan initially.

3. In fact, the entire U.S. government is in some way responsible for maintaining the dollar's purchasing power. Perhaps the most accountable body is the U.S. central bank, the Federal Reserve. Congress and the president, however, also play a role.
The Fed plays a major role in regulating the money supply in the U.S. For example, when the Fed increases the supply of money, the dollar's purchasing power may decline. Congress also affects the dollar's purchasing power. This is because it controls the fiscal policy of the nation (along with the president).