Theory of money

Monetary economics is a branch of economics that provides a framework for analyzing money in its functions as a medium of exchange, store of value, and unit of account. It considers how money, for example fiat currency, can gain acceptance purely because of its convenience as a public good. It examines the effects of monetary systems, including regulation of money and associated financial institutions and international aspects.

The discipline has historically prefigured, and remains integrally linked to, macroeconomics. Modern analysis has attempted to provide microfoundations for the demand for money and to distinguish valid nominal and real monetary relationships for micro or macro uses, including their influence on the aggregate demand for output. Its methods include deriving and testing the implications of money as a substitute for other assets and as based on explicit frictions.

Serious interest in the concepts behind money occurred during the dramatic period of inflation known as the Price Revolution, during which the value of gold fell precipitously, sometimes fluctuating wildly, because of the importation of gold from the New World, primarily by Spain.

At the end of this period, the first modern texts on monetary economics were beginning to appear.

In 1705, John Law in Scotland published Money and Trade, which examined the failure of metal-based money during the previous 150 years, and proposed replacing it with a land bank system of paper money based on the value of real estate. Though he succeeded in getting this proposal implemented, he failed to take the lessons of the Spanish Price Revolution seriously enough, and his bank failed, a bubble of speculation collapsing into extreme inflation.

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