Basic concepts of monetary and financial systems


Evolution of money

In early stages of human life, individuals traded their excess goods for other products. Early trading activities were characterised by the barter system. This involved direct exchange of a good or goods for another or others. Exchange in the barter system was possible when both parties had mutual need for the goods to be exchanged. Without mutual need, it was almost impractical for barter to take place. Challenges associated with the barter system created the need for a common medium that would facilitate exchange between two parties. Money was therefore introduced.

Early exchanges in Africa were carried out through the barter system. Given the challenges associated with the barter system, trading in Africa from the 11th century involved the use of goods that were generally acceptable among traders in the community as a medium of exchange or money. This money was called commodity money. Some commodities used as money included:

  1. Gold, which was mostly used as commodity money in Dahomey, other parts of West Sudan and Ghana Empire from the 11th century.
  2. Salt, cloth, Aggrey-beads, mats, gin, holed-stones, slaves, cattle, gunpowder, guns, sheep, goats and hoes. Cowry shells were used essentially in the Maldives Islands, Chad, Niger and other West African countries.
  • Brass, copper and iron bars were used mostly in Central Africa, Sierra Leone and Nigeria from the 14th century.

The use of cattle as commodity money was very popular around the world. Till today, the Latin word for cattle, pecus, is generally expressed to mean money. The foregoing commodities are referred to as transitional moneys, because they were introduced between the barter era and introduction of European moneys.

Definition and characteristics

Money was traditionally defined as anything that is generally accepted as means of exchange for goods and services. Today, it can be described as a financial asset or instrument that is generally accepted as means of payment for goods and services. It is used to settle debt; and forms an integral part of individuals’ and organisations’ assets.

Generally, any financial asset that is used as money must exhibit the following eight characteristics: it must be generally acceptable; exhibit stability in its value; and should be scarce by nature. Further, it must ensure portability; durability; satisfaction and convenience; facilitate day-to-day operations; and ensure homogeneity.

Money must be generally acceptable to traders of all forms in any given economic jurisdiction. It must have legal backing to compel its acceptance in payment and debt settlements. Further, it must be stable in value. The inference is that to be accepted as a medium of exchange, money must not lose its value frequently relative to the fixed value of goods and services within the economy. Countries saddled with hyperinflation tend to change their currency; others index-link some financial assets like social security benefits and taxes to assure stability.

Scarcity is the third essential characteristic. This implies money must be limited in supply; the central bank must regulate the activities of banks to control lending; it must not be as common as the sand which could be tipped easily by anyone in the home, street or elsewhere. Individuals must work to earn money. In addition to the foregoing, money must be portable. This suggests money must have high value, but should be carried about; and able to be transferred for debt settlement and other important payments with relative ease.

It is important for money to be durable, implying money must have store of value. The currency used as money should last for a considerable number of years; failure to store money effectively must result in a loss to the bearer. To ensure satisfaction for change and convenience of buying and selling, money must be divisible. To illustrate, denomination of the country’s currency into specific ratios such as GH¢100, GH¢50, GH¢20, GH¢10 and GH¢5 facilitates payments, settlement of transactions and application of change, when and where necessary.

Money must be readily recognised by parties involved in a transaction or transactions to ease day-to-day operations of organisations. Easy recognition creates the enabling environment for individuals, businessmen and businesswomen, and the general public to identify and reject (with relative ease) counterfeit coins and notes. Uniformity or homogeneity is the last characteristic of money. This underscores the need for each unit of currency in the same denomination to be identical. The same unit of currency must be deposited across banks within the economy.


The functions of money resonate with its definition, including serving as medium of exchange; unit of account; store of value; and standard of deferred payment.

Efforts toward finding solutions to challenges associated with the barter system necessitated the introduction of money as a common medium of exchange among individuals and traders. Evidence suggests money facilitates eliminating the likelihood of double coincidence of wants in transactions.

The term ‘unit of account’ is indicative of the fact that money must be divisible, countable and fungible. That is, one unit must be the same as the other with no change in value. In Ghana, the unit of account is the Ghana cedi. In its practical usage, one observes a Ghana cedi is the same as another Ghana cedi; there is no change in their value. ‘Countable’ allows individuals to account for revenues, expenses, profits, losses, debt and wealth. Money serves as the standard for measuring values.

Akin to money’s functionality as a unit of account is its store of value, which emphasises the formation of hoards or accumulation of funds to ease future payments. It should be possible for individuals to save money to meet future business needs and mitigate unforeseen market contingencies. Non-circulation of money increases its accumulation and storage. One of money’s unique qualities is its ability to link past, present and future time periods. This underscores the need for money to maintain its value in the present and future.

Finally, money serves as standard of deferred payment. This function is closely linked with the function of assets. Accumulation of money makes it possible for individuals to make rent, wages and tax payments at a future date. This function makes it possible for some debts to be cancelled mutually – making it possible for the amount of money needed for circulation to be reduced to desired or appreciable levels.

Liquidity concept

As part of its functions, money is described as liquid store of value. This implies a financial asset that could be converted into easily spendable means of payment whenever the holder wants. Liquidity therefore places an emphasis on a person’s ability to transform wealth-holding into cash, without delay or loss of value.

Money’s description as liquid store of value implies money stores value of wealth for individuals and businesses; people could possess money with a high level of certainty that its value would be stable or maintained in the near and distant future, controlling inflation. Quite importantly, money serves as liquid asset. Cash is the most liquid form of all financial assets; it can be spent without strict conditions. A non-cash asset may also be liquid, if it can be converted into cash within a short period and without significant loss or penalty.

‘Penalty’, as affirmed earlier, may mean loss of capital; loss of face value; and loss or forfeiture of a substantial amount of interest. An alternative to money in the form of cash and non-interest-bearing deposits is to hold interest-bearing financial assets to maturity. Examples of interest-bearing financial assets include certificates of deposit (CDs), debentures or bonds. The opportunity cost of liquidity is the interest holders of financial assets forgo. The sacrifice may be significant or small. The smaller the loss, the greater the liquidity.

Assets whose conversion to cash entails a high level of sacrifice cannot be easily and properly classified as liquid. The liquidity of long-term financial assets increases as their maturity dates approach. A major contributor to the Theory of Money is W.T. Newlyn. This seminal writer outlines five relative advantages of money in the modern economy: holding money must not involve cost; money should not be marketed to facilitate its conversion into means of payment; and it must not (normally) earn income. The rest include certainty surrounding the absolute value of money must be significant; and controlling for inflation, certainty surrounding the real value of money must be high.

Liquidity of financial assets

Different forms of financial assets are used by individuals and businesses in Ghana. These include currency; current accounts; foreign currencies; Cedi travellers’ cheques; building society term deposits; service cards; Barclaycard; government Treasury bills; bank acceptances; call and time deposits; certificates of deposits (CDs); commercial paper (CP); guilt-edged securities; loan stocks; and company shares. Each of these financial assets is discussed to determine whether or not it is money, and the extent to which it can be readily converted into cash.

Currency performs all the functions of money, and meets the five relative advantages outlined by W.T. Newlyn. For obvious security reasons, however, individuals and businesses are reluctant to hold it in large quantities. Rather, they would prefer to deposit it at a bank; or channel it into other investment vehicles. The current account is also called sight deposit account, demand account or chequeable account. In other jurisdictions, it is called a checking account. Using cheques facilitates the transfer of funds from one individual’s account to another; and this eases payments.

Foreign currencies are not considered as legal tender; they must be sold before being spent. Readily convertible currencies such as the United States dollar are now included in the broad classification of money. Some government and private institutions make and accept payments and save in United States dollars. This affirms its liquidity in Ghana.

Cedi travellers’ cheques are issued in different denominations by GCB Bank (formerly Ghana Commercial Bank) for travellers within the country. These cheques are not legal tender. However, they are widely accepted by individuals and businesses throughout the country. They are used in designated shops, and their spending is preceded by marketing.

Building society term deposits are not chequeable in Ghana. For withdrawal to take place, the cheque must be issued by the building society and encashed in a designated bank before spending. Service cards are available at all Standard Chartered Bank branches in the country. They guarantee cheques up to a certain amount on each transaction. There is a money line service which guarantees payment up to a higher amount. Both can be used in any branch of the bank, specified restaurants and fuel stations, and commercial houses. Unlike other jurisdictions, use of credit in Ghana is restricted, and conditionally accepted for payment.

The Barclaycard is issued by Barclays Bank of Ghana. Functions of the Barclaycard are similar to those of the service card; it guarantees payment at member shops, filling stations and businesses. It is restricted and conditionally accepted for payment.

Government Treasury bills remain financial instruments that are highly liquid. There is an active secondary market for purchase and sale of existing bills. They are traded on the discount market. Holders can rediscount them pre-term without significant loss of capital or income. Generally, Treasury bill must be sold before being spent. In view of this, it is described as a money surrogate or quasi-money.

Bank acceptances are bills issued by firms and rediscounted on existing secondary markets. The bills are categorised into three: eligible bills are acceptable or guaranteed by the central bank; ineligible bills are neither accepted nor approved by the central bank; and trade bills do not carry the acceptance of a bank. They are least secure, and thus give the highest yield. The secondary market for trade bills is not active, except in the case of fine trade bills. That is, bills issued by blue-chip or very reputable companies.

Clearing banks, acceptance houses and building societies accept call and time deposits of wholesale funds from individuals and businesses. The term of call deposits varies from overnight to seven (7) days. However, time deposits range between three (3) and twelve (12) months or more. These carry interest, but there is no secondary market for moneys at call and short notices.

Certificates of deposit (CDs) are issued to depositors against large deposits, and are intended for specific periods. They attract fixed interest rates; they are negotiable; and have an existing active secondary market, though they operate in the same way as call and time deposits. CDs are more liquid than time or call deposit.

Commercial paper (CP) is a short-term financial instrument comprising unsecured promissory notes with fixed maturity ranging from 7 days to 3 months, issued in bearer form and on discount basis. Commercial paper is a form of securitisation. That is, it assists firms to raise funds between themselves. Banks act as managers of the CP issue, advising the issuing firms; but do not act as intermediaries for them. This means banks raise funds for customers by hoarding and selling their customers’ securities without lending to them. There is a primary market for the issue of CP, and a secondary market for trading in them.

Other bills such as the mineral bills, cocoa bills, and Bank of Ghana bills, among others, are operated like Treasury bills.

Gilt-edged securities are government stocks, and are of long-term duration. These securities carry a minimum of risk in relation to regular payment of interest on due dates, and redemption of the stock on maturity. Gilts, as these securities are simply called, are classified as liquid only if they are nearing maturity. They are generally regarded as non-monetary assets due to the long-dated nature of their maturity; and some are undated.

Loan stocks are also called bonds or debentures, and relate to borrowings that increase the capital of issuing companies. They are generally issued by reputable firms. Holders of loan stocks are creditors of the issuing companies. Loan stocks rank ahead of all types of shares for payment and of interest on them. The interest due on loan stocks is fixed, usually a little lower than that on preference shares. They are redeemable at par. However, there could also be irredeemable loan stocks. Therefore, like gilts, loan stocks are classified as liquid only when they are close to maturity. Irredeemable stock can be traded on the Stock Exchange.

Company shares are expected to be withdrawn, and represent capital participation in a company. Companies are presumed to have perpetual existence. To this end, company shares are considered as perpetual debts. Functions of the Stock Exchange allow for shares ownership to be shifted from one person to another. Shares are not convertible into cash in their own right; therefore, they are non-monetary assets.

Liquidity and Money in Modern Economy

In Ghana, some financial assets are identified as highly liquid. However, only the Ghanaian banknotes, coins and sight deposits are classified as cash. Thus, the basic tenet of money in modern economy is a matter of degree. Therefore, liquidity is the degree of moneyness of financial assets. Sometimes, the dividing line between money and quasi-money tends to be blurred because money performs four functions, not one. The functions can be met in different degrees by different financial assets, but they must be combined with the relative advantages to impart to an object the quality of generalised purchasing power.

Technical definitions

The technical definition of money involves the use of monetary aggregates in the process. Monetary aggregates relate to official statistics used to classify the volume of money in an economy. Generally, financial assets may be classified under any of the following monetary aggregates: M0, M1, M2, M3, and so on.

M0 is defined as the wide monetary base, including currency in circulation, till-money and bankers’ operational deposits with the central bank. Till-money relates to the money kept by a bank on its premises to meet day-to-day cash requirements. Monetary measures vary from one country to another. Nonetheless, the ensuing monetary aggregates are published by Ghana:

M1: The Bank of Ghana terms this monetary aggregate as the money supply or narrow money. It consists of currency with the public; that is, currency outside the banking system; and demand deposits. The definition of M1 in Kenya and many other countries includes time deposits.

M2: The Bank of Ghana terms this monetary aggregate as the total liquidity or broad money. It includes M1 plus quasi-money, which comprises savings deposit, time deposits; and certificates of deposit with the deposit-money banks (DMBs). M2+ is the broader definition of money; it comprises M2 plus foreign currency. Foreign currency is denoted by (+).

Ghana uses M1, M2, and M2+ to target its macro-economic objectives. Due to the high rate of inflation, growth in narrow money has been largely on account of currency outside the banking system. For instance, from October 1997 to December 2000, currency outside the banks increased from GH¢678.4billion to GH¢1,739.1billion, representing a 156.4% increase. Over the same period (October 1997 to December 2000) demand deposits increased from GH¢545.8billion to GH¢867.7billion, indicating a 59% increase.

During the same period (October 1997 to December 2000), Ghana’s broad money supply (M2) increased from GH¢1,862.6billion to GH¢4,395.2billion, accounting for 136% increase. In the period covering October 1997 and December 2000, Ghana’s broad money supply (M2) plus foreign currency – that is, M2+ – increased from GH¢2,419.8billion to GH¢6,338.4billion, representing a 161.9% increase.

Significant increases in M2+ during the period can be attributed to revaluation gains of the available foreign exchange. Foreign currency deposits increased from GH¢557.2billion to GH¢1,943.2billion, indicating an increase of 248.74%. This increase was absorbed into the calculation of the M2+ (Inkoom, 2009).

Broad Money in 2022

Ghana has experienced substantial fluctuations in broad money growth in recent years.  The country ended 2022 fiscal year with broad money growth of 33.4%; and the World Bank believed the country experienced decline in average broad money growth from 1973 through 2022. Broad money as a percentage of Ghana’s gross domestic product (GDP) in 2022 was estimated at 29.4%, while broad money as percentage of the country’s total reserves ratio during 2021 was 2.36%.

The country ended 2022 fiscal year with a bank liquid reserves to bank assets ratio of 48.1%. overall, Ghana experienced an increase in average broad money as a percentage of GDP from 1973 through 2022. The substantial fluctuation and decrease in Ghana’s broad money to total reserves ratio from 1972 through 2021 culminated in a ratio of 2.36% during 2021. The 48.1% bank liquid reserves to bank assets ratio recorded in 2022 was a reflection of the average increase experienced from 2003 through 2022. Money supply or narrow money increased from 79,351 (LCU) during 1973 to 181,112 million LCU in 2022. The annual growth rate during the period was 35.52% (World Bank as cited in, 2023).

Financial Assets and Definition of Monetary Aggregates

Discussion in the preceding section affirmed the number of financial assets in Ghana is between fourteen (14) and sixteen (16). However, there are only three monetary aggregates (M1, M2, and M2+) serving as measures to effectively account for flow of money in the economy. To address this challenge and improve the trend, monetary experts believe the existing aggregates must be extended to account for some quasi-money not included in the definition. Some of these quasi-money variables are discussed in the next section.

Non-monetary assets include shares, bonds, stocks, currency held in central bank vaults, Treasury or government accounts, accounts held by central bank, dormant accounts and unused credit facility. Non-monetary assets are not included in any of the monetary aggregates.

Currency held in central bank vaults is not part of money supply; it does not affect the expenditures of banks. Thus, it has no impact on the level of inflation. It becomes money only when it is transferred from the Issue Department (the vaults) to the banking system, including the Banking Department of the Bank of Ghana, for payments to the general public.

Treasury or government accounts such as cash in vaults do not affect the level of inflation in the country. It is therefore essential for these accounts to be deleted from the total demand deposits figures. These accounts hold money withdrawn from circulation. Government expenditure does not hinge on its outstanding balance, but on policy (Parliamentary or Cabinet approval). The economy’s behaviour sometimes influences government’s expenditure decisions.

Unlike commercial banks, the central bank operates for and on behalf of government; the central bank’s accounts are government accounts. As a result, moneys held in these accounts must be ignored when determining total demand deposits.

Dormant accounts refer to inactive accounts; they are accounts that have been left unattended by the depositor for a relatively long period of time. Normally, balances in dormant accounts are closed and transferred to a suspense account in order not to affect money supply. For this reason, dormant account balances are not included in any of the monetary aggregates.

Unused credit facilities are not considered as part of means of payment. Overdrafts result in the creation of automatic credit lines; and money supply increases only when consumers spend. Unused portions of credit facilities must be excluded from the computation of money supply.

Reasons for Diverse Definitions

The existence of several definitions for money stems from its use for different purposes.

First, governments control the supply of money because it is widely held that growth of the stock market has effects on employment, investment, inflation, output and balance of payments. A specific monetary measure is required to fulfil each objective. For instance, government requires the narrow definition if it seeks to curb inflation; any of the broader definitions would be required if the intention is to estimate the growth of national income.

Second, while Ghana’s economic system is developing at fast rate, its financial system is developing at steady rate. This results in less funds available to meet the expected amounts for economic activities. To address this challenge, all kinds of surrogate moneys or money substitutes are used in the economy. The use of surrogate moneys by banks, companies and individuals may make it difficult for experts to control specific monetary aggregates in an attempt to establish statistical relationships within given monetary aggregates.

Third, authorities in charge of monetary policies are interested in employing methods which can measure the purchasing power and demand of the private sector. The choice of best or unique measures has become a challenge due to differences in opinion. It is believed no single statistical measure can effectively summarise the stock of money, and provide a unique and correct basis of controlling the complex relationships between the growth of money supply, prices, and nominal incomes.

Finally, the desire to spend and save underlies demand for money. Generally, an individual’s desire changes from time-to-time; and this reflects corresponding changes in the composition of the money stock.

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