Definition
Fiat money is any currency that a government declares to be legal tender but that doesn’t have intrinsic value or is not backed by reserves. Instead, its value comes from the public’s trust in the issuing authority, usually a central bank or a national government. In contrast to commodity money that is based on a good with intrinsic value, fiat money has neither intrinsic value nor a fixed value in terms of a commodity.
Examples
- United States Dollar (USD): The Federal Reserve Note is the most prominent example. It’s used widely for all kinds of transactions and is backed solely by the U.S. government’s ability to maintain economic stability and enforce the use of the currency.
- Euro (EUR): The primary currency in the Eurozone, which consists of 19 of the 27 European Union member states. The value of the Euro is primarily based on the economic stability and policies of the European Central Bank and the collective economies of the member countries.
- Japanese Yen (JPY): Like other fiat currencies, it is supported by the economic policies of Japan’s central bank and government.
Frequently Asked Questions (FAQs)
Q: What gives fiat money value? A: Fiat money derives its value from the trust that individuals and businesses have in the government issuing the currency, as well as the government’s ability to maintain that trust. It’s also given value through laws that demand it’s used for payments of taxes and for settling debts.
Q: How is fiat money different from commodity money? A: Commodity money is backed by a physical good, such as gold or silver, that has intrinsic value. Fiat money, on the other hand, has no intrinsic value and is not backed by reserves; its value is based purely on government regulation and the trust of the users.
Q: What are the risks associated with fiat money? A: The main risks include inflation, hyperinflation if the government overprints currency, and the loss of public trust. Unlike commodity-backed currencies, fiat money can be subject to rapid devaluation if the issuing government fails to maintain economic stability.
Q: Can fiat money fail? A: Yes, fiat money can fail if the issuing authority loses credibility, usually due to poor economic management, leading to inflation or other economic crises. Historical examples include the hyperinflation of the German Papiermark in the 1920s.
Q: How does fiat money affect monetary policy? A: Fiat money gives central banks the flexibility to implement monetary policies to manage the economy. For example, it allows for quantitative easing, interest rate adjustments, and other tools to control money supply and influence economic conditions.
Related Terms
- Legal Tender: Currency that must be accepted if offered in payment of a debt.
- Commodity Money: Money that has intrinsic value and can be used as a commodity itself, such as gold coins.
- Inflation: A general increase in prices and fall in the purchasing value of money.
- Central Bank: The national bank that provides financial and banking services for a country’s government and commercial banking system, also implementing government’s monetary policy.
- Money Supply: The total amount of money in circulation or in existence in a country.
Online Resources
- Federal Reserve - What is fiat money?
- European Central Bank
- Investopedia’s Explanation of Fiat Money
Suggested Books
- The Ascent of Money: A Financial History of the World by Niall Ferguson
- Money: The Unauthorized Biography by Felix Martin
- The Mystery of Banking by Murray Rothbard
- The Future of Money by Bernard Lietaer
Fundamentals of Fiat Money: Economics Basics Quiz
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