What is a Monetary System?

Felicia Dye

A monetary system is a scheme developed by a government to facilitate exchange. It also provides a means to generate and measure wealth and debt. These measurements are generally made using currency, which is an important part of a monetary system. Banks are another essential part of the system, which play roles such as distributing money and converting monetary instruments into cash.

Currency, including coins, are an essential part of a monetary system.
Currency, including coins, are an essential part of a monetary system.

One of the most essential functions of a monetary system is that it provides a means to establish and gain value. Currency, or cash, is an essential part of each system. This includes paper money and coins, both of which are commonly made by state-owned facilities. These are generally the most widely accepted mediums of exchange within a monetary system, but there are others, such as checks, debit cards, and credits cards.

When a cost is placed on goods and services, currency allows for an exchange. One person gets the desired item, and the other gets an instrument of monetary value. If that instrument is cash, it can immediately be used for further exchange within that same system. The currency used within one monetary system, however, is generally not valid in another. This means that exchanges between citizens of different governments often require conversion of their monetary instruments.

A monetary system also provides a means to keep a tally of peoples’ wealth or debt. Wealth refers to a situation where a person has money, and debt refers to a situation where a person owes money. A person’s position in either of these categories is likely to be in a constant state of flux. Usually, individuals aim to earn as much wealth as possible because this provides them with more value to exchange for goods and services.

In monetary systems where credit cards are utilized, a person does not need currency to obtain goods and services. Instead, she can exchange debt to get what she wants. Her creditor will provide payment to the party that she is exchanging with. Then she will need to repay her creditor, usually with interest. This aspect of a monetary system is believed to have the potential to create a great deal of harm if it is not carefully regulated and people do not exercise personal responsibility.

Banks are another essential part of a monetary system. These facilities play a number of roles, such as distributing currency and holding money in personal bank accounts. Banks make loans to individuals who need money for various reasons, such as to build a house or to start a business. They also convert monetary instruments such as checks and money orders to cash.

In addition to the financial institutions that service the general public, each system usually has a central bank. This facility can generally be considered the most powerful bank in the land. As such, it usually bears serious responsibilities. These include regulating the amount of currency in circulation, determining interest rates, and lending money to other banks.

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