Money is essential to the workings of a modern economy but its nature has varied substantially over time. Money today is a type of IOU (‘ I owe you’) but one that is special because everyone in the economy trusts that it will be accepted by other people in exchange for goods and services.
There are three main types of money ; currency, bank deposits and central bank reserves. Each represents an IOU from one sector of the economy to another. Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves.
Most people in the world use some form of money on a daily basis to buy or sell goods and service, to pay or get paid or to write or settle contracts. Money is central to the workings of a modern economy. But despite its importance and widespread use, there is not universal agreement on what money actually is. That is partly because what has constituted money has varied over time and from place to place.
Many different goods or assets have been used as money at some time or in some place. Goods are things that are valued because they satisfy people’s need or wants, such as food, clothes or books. An asset, such as machinery is something that is valuable because it can be used to produce other goods or services. One common way of defining money is through the functions it performs. This approach traditionally suggests that money should fulfil three important roles.
The first role is to be a store of value – something that is expected to retain its value in a reasonably predictable way over time. Gold or silver that was mined hundreds of years ago would still be valuable today. But perishable food would quickly become worthless as it goes bad.
The second role is to be a unit of account – the thing that goods and services are priced in terms of, for example on menus, contracts or price labels. In modern economies the unit of account is usually a currency.
The third role is to be a medium of exchange – something that people hold because they plan to swap it for something else, rather than because they want the good itself.
These functions are all closely linked to each other.
Source :- Bank of England