Controlling the money supply of a nation is a critical task that falls most often to governments and central banks. If there is too much money in circulation, inflation results; too little money, and the economy contracts. The goal is to strike a balance so that there is enough money to stimulate the economy, but not so much that the economy overheats. In the United States, money supply is controlled through fiscal (tax) policy and monetary policy. The government controls the fiscal policy, while the monetary policy is controlled indirectly by the government through the central bank in most modern economies.
Money serves several different purposes in today's economies. First and foremost, it is the common medium of exchange that eliminates the barter system. Instead of trading apples for oranges (or guns for butter), money provides a single exchange mechanism for all transactions within an economy. Money can be used to pay for time, products, services, and all other transactions (including financial transactions such as paying interest) that take place in an economy. Far more efficient than barter, money makes modern capitalism possible. Money is also the standard unit of accounting for expressing prices both in current and future terms. Thus when someone makes a purchase for $1000 today and agrees to pay $1200 in the future for that purchase, both parties understand the price as stated in monetary terms (Samuelson 1989).
Money is also a safe and tangible way to hold assets. While few Americans keep all of their assets in the form of cash (many have homes, cars and financial instruments such as stocks and bonds and actually relatively little cash), some amount of cash is a hedge against the fluctuations of these other assets. During times of inflation, holding cash results in a net loss to the consumer, but during times when prices are stagnant or declining, holding cash can be a smart business strategy. Holding cash...