1.3 The Challenges of Traditional Money

While money is indispensable for modern economic life, no form of it—whether metal coins, paper notes, or today’s digital systems—has ever been free of problems. Each system has solved old difficulties only to introduce new ones, and even the most advanced currencies still face serious risks. Economists generally group these challenges into three broad areas: inflation and currency depreciation, centralization and trust, and unequal access. These issues remind us that money is not a perfect instrument, but rather a fragile human institution that depends on confidence, careful management, and broad participation.

Inflation and Currency Depreciation

Inflation is the general rise of prices over time, meaning a unit of currency buys less. Mild inflation is normal in growing economies. Central banks often aim for 2-3% annual inflation. But excessive inflation erodes savings and destabilizes economies. When governments print too much money, or lose control of currency supply, prices can spiral out of control. Hyperinflation (extreme inflation) is commonly defined as monthly inflation above 50%.

Historical hyperinflations illustrate the problem. In early 20^th century Germany, war reparations and debt led to massive money printing. By late 1923 one US dollar cost about one trillion marks. In that Weimar hyperinflation, a wheelbarrow full of banknotes barely bought a newspaper. People needed piles of cash just to buy bread, and wages and prices were changing hourly. Hyperinflation turned savings worthless and caused desperate hardship. Similarly, in Zimbabwe in the 2000s, government deficits and declining output led to catastrophic inflation. The central bank issued a 100 trillion Zimbabwe dollar note in 2009—arguably the largest ever. Between 2007 and 2008, the Zimbabwe dollar lost over 99.9% of its value, reversing decades of parity with the US dollar. In one year, annual inflation exceeded 231 million percent. People’s life savings vanished, shops ran out of goods, and the country’s breadbasket economy collapsed into poverty.

Chronic inflation also undermines trust in money. If currency loses value unpredictably, neither individuals nor businesses can reliably plan for the future. In some countries today, regular citizens worry that inflation will devalue their salaries and savings within months, even years. For example, Venezuela’s recent crisis saw inflation in the tens of thousands of percent, pushing people to hoard scarce commodities or convert savings to foreign currencies. In short, uncontrolled inflation is like a stealth tax on anyone who holds the currency, encouraging people to find more stable stores of value.

Why Inflation Happens — The Mechanisms and Common Drivers

Inflation does not arise from a single, uniform cause. Instead, it typically reflects the interaction of several mechanisms, with the relative importance of each varying across time and context.

1. Excess nominal money growth relative to real output.

The quantity theory of money, expressed as MV = PY (where M is the money supply, V is velocity (how quickly money moves through the economy), P is the price level, and Y is real output), provides a useful framework. It suggests that, holding velocity and output constant, sustained increases in the money supply will be reflected in higher prices. While in reality both velocity and output fluctuate—meaning the relationship is not one-to-one—historical evidence shows that persistent and rapid monetary expansion, particularly when used to finance government deficits, has been a central factor behind episodes of very high inflation.

Empirical studies, including long-run cross-country analyses by the IMF and central banks, confirm that chronic reliance on money creation to fund fiscal shortfalls is closely associated with severe and prolonged inflationary outcomes. In this sense, monetary expansion beyond the productive capacity of the economy is not merely a correlation but a core mechanism through which inflationary pressures emerge.

2. Monetization of fiscal deficits.

When governments run big deficits (spend more than they collect) and the central bank (formally or effectively) finances them by creating (printing) money, that monetization can fuel inflation. History shows this as being central to many high-inflation episodes. If the public expects the government to avoid reforms and rely on printing money, inflation fears grow, people spend faster, and prices rise more quickly.

3. Loss of credibility and self-fulfilling expectations.

Monetary dynamics are psychological as well as mechanical. If households and firms believe inflation will continue, they raise wages and prices to keep up. This can create a feedback loop that, along with excessive money printing, may lead to hyperinflation—a process explained in models by Cagan and others.

4. Supply shocks and exchange-rate pass-through.

When supplies are badly disrupted—like during wars, crop failures, or commodity shocks—costs go up. If the country’s currency also loses value, imports become more expensive, adding to inflation. How much of that increase shows up in domestic prices depends on how the economy works and how persistent inflation is. Research by the Bank for International Settlements (BIS) and International Monetary Fund (IMF) shows this effect is especially strong in emerging markets and countries that rely heavily on imports.

How the Mechanisms Interact

In practice these mechanisms rarely act in isolation. Political instability or weak governance can shrink the economy and reduce tax revenues, widening budget deficits. If the government responds by printing money, inflation rises due to both supply shortages and excess demand. At the same time, loss of policy credibility causes firms and households to start raising prices and wages faster, which speeds up inflation. Historical surveys and cross-country shows that hyperinflation usually happens when several problems hit at once—including fiscal trouble, money printing, broken public trust, and often an external shock like a commodity crash or capital flight.

How Inflation and Depreciation Affect People and Institutions

• Erodes real (inflation-adjusted) savings and incomes. As inflation increases, people with cash or regular bank savings lose purchasing power as prices rise. Those on fixed incomes or long-term pensions are particularly vulnerable. Research and central-bank notes emphasize that unexpected inflation redistributes wealth from savers to debtors (borrowers) and can permanently impair retirement savings.
• Breaks the unit-of-account and complicates contracts. When prices change quickly, long-term contracts become risky unless they’re adjusted for inflation. It also becomes harder for tax and accounting systems to reflect actual values, and this uncertainty can hold back investment.
• Raises transaction costs. High inflation makes transactions more expensive. Businesses change prices more frequently, as well as dealing with rising administrative costs, whilst households may rush to spend or exchange cash before it loses value. In extreme situations, people may avoid local money altogether and switch to foreign currency or bartering.
• Worsens inequality and social outcomes. Inflation rarely hits everyone equally: the poor and those with little access to inflation-hedged assets (property, foreign currency, indexed bonds) tend to suffer most. The broader macroeconomic instability can lead to unemployment spikes, shortages, and social unrest.

Measuring and Diagnosing Inflation: What Policymakers Watch

When exploring the challenges of traditional fiat money, it's worthwhile to examine how policymakers monitor and diagnose this issue. Understanding the key indicators they track can give you a clearer picture of why these systems struggle and how instability arises. As you advance in your understanding, it'll sharpen your ability to evaluate broader economic ("macro") conditions that directly influence cryptocurrencies, such as interest rate decisions, market volatility, or crypto's role as a potential inflation hedge.

Policymakers charged with price stability, draw on a range of indicators rather than a single metric. The most closely watched series include headline and core measures of consumer prices, producer prices, various measures of inflation expectations, monetary aggregates, exchange-rate behavior, labor-market and cost indicators, and output-gap measures. Central banks combine these data with model forecasts and judgment to assess whether inflationary pressures are temporary (for example, from a one-off supply shock) or persistent and broadening.

Here's a concise summary of what policymakers commonly watch to measure and diagnose inflation—think of these as diagnostic tools for the economy's health:

Headline vs. Core Inflation

• The headline CPI (Consumer Price Index) measures the overall change in prices paid by consumers and therefore captures the direct effect of price movements on household living standards. 
• Core CPI removes items like food and energy that tend to have big price swings. This helps show the underlying trend in inflation, which is more useful for central banks. While it's not perfect and can miss lasting changes in those excluded areas, it helps policymakers avoid reacting too strongly to short-term price spikes.

Producer and Import Prices

The Producer Price Index (PPI) tracks price changes for goods sold by producers, often before those changes reach consumers. Rising producer or input costs can lead to higher prices in stores. Similarly, import prices and commodity prices, such as oil, give early warnings of rising costs, especially in countries that rely heavily on imports. Policymakers use these indicators to spot signs that cost increases are starting to affect consumer prices.

Personal Consumption Expenditures (PCE) Price Index

Similar to CPI but broader, focusing on what people actually spend (including shifts in buying habits). It's often the Fed's preferred gauge because it captures real-world behavior more flexibly.

Inflation Expectations

Expectations shape behavior. If firms and households expect higher inflation, they raise wages and prices, potentially making inflation self-fulfilling. Policymakers therefore track both:

• Surveys, like the Survey of Professional Forecasters (SPF) or household surveys from central banks (e.g. the New York Fed’s Survey of Consumer Expectations), which directly show what people expect.
• Market-based measures:, such as breakeven inflation from Treasury Inflation-Protected Securities (TIPS), which reflect investor expectations but also include factors like market liquidity and inflation risk.

Policymakers routinely compare both types of measures to form a balanced view.

Money Aggregates (M1, M2)

Central banks track monetary aggregates like M1 and M2, which measure the money supply.

• M1 includes the most liquid forms of money, such as cash and checkable deposits.
• M2 includes everything in M1, plus less liquid assets like small time deposits and retail money-market funds.

Although monetary theory suggests a strong long-term link between money supply growth and inflation, in practice, this relationship is less consistent in the short run and varies across countries and time periods.

As a result, modern central banks use money supply data as a helpful signal rather than a direct policy target.

Rapid and sustained growth in money supply can indicate future inflation risks, but central banks also consider other factors—like credit trends, money velocity, and changes in the financial system—before making decisions.

Exchange Rates and Pass-Through

Changes in exchange rates can influence domestic prices through a process called exchange-rate pass-through.

When a country’s currency depreciates (loses value), the cost of imported goods and inputs in local currency goes up. This can lead to higher consumer prices.

However, the degree of pass-through varies by country:

It is usually stronger in emerging markets.

It is typically weaker in advanced economies, especially where inflation expectations are stable and well-anchored.

Labor Market and Cost Pressures

Labor market indicators like wage growth, labor force participation, unemployment, and unit labor costs help measure domestic inflation pressures from the supply side.

When the labor market is tight (low unemployment, strong demand for workers), wages tend to rise. This can lead to higher inflation in services, which now makes up a large part of core inflation in many advanced economies.

Central banks use labor market data—especially signs of slack or tightness—to assess whether inflation is likely to persist. For example, the Bank of England and others often highlight wage growth as a key channel through which inflation can build.

A Diagnostic Toolkit

When assessing inflation, central banks follow three key rules of thumb:

1. Look beyond headline inflation:
   Compare headline and core inflation, and examine leading indicators like producer prices, import prices, and wage growth.
2. Examine inflation expectations carefully:
   Compare survey-based measures (like the SPF and SCE) with market-based indicators (such as breakeven inflation rates).
   Be sure to account for liquidity issues and risk premiums that can distort market signals.
3. Put money growth and exchange rates in context:
   Don’t view them in isolation—interpret them as part of a wider picture involving demand, supply, and fiscal policy.
   If there's sustained money creation or a persistent fiscal deficit, prices are likely to rise unless confidence and strong institutions are maintained.

These tools help central banks judge whether inflation is just a temporary shock or a sign that expectations are becoming unanchored—which would require stronger policy action.

How Crises End — Policy Responses and Anchors

To restore price stability during or after an inflation crisis, governments and central banks typically take several key steps:

• Tighten monetary policy—usually by raising interest rates.
• Cut fiscal deficits through fiscal consolidation (reducing government borrowing).
• Rebuild central bank credibility, often by restoring its independence.
• If the system is severely broken, introduce a new nominal anchor—such as a currency reform, a currency board, or adopting a foreign currency.

Examples include:

• Germany’s Rentenmark (used to stop hyperinflation in the 1920s).
• Dollarization or multi-currency regimes in countries that abandoned their own currency.

However, research shows that currency reform alone isn’t enough. Without credible fiscal policies and strong institutions, these fixes rarely lead to lasting recovery.

Centralization and Trust Issues

Money in modern economies is overwhelmingly centralized:

• Central banks issue official currency.
• Commercial banks create most of the deposit money people use.
• A small number of payment systems (like Real-Time Gross Settlement (RTGS), card networks, and major fintechs) move money around.

This centralization provides major public benefits:

• Coordinated monetary policy
• Efficient settlement and liquidity management
• Standardized consumer protections

But it also creates risks:

• Power is concentrated in a few hands.
• There are single points of failure in the system.
• People must place a lot of trust in a few key institutions.

History shows that this trust isn’t always warranted—and when it breaks down, the consequences can be serious.

Why Centralization Exists

Central institutions exist because they provide essential services that are too costly or complex to organize in a fully decentralized way:

1. Monetary Policy and Economic Stability
Central banks manage interest rates, control liquidity, and act as lenders of last resort during crises.
This coordination helps prevent large-scale economic collapses—but it depends on public trust in the bank’s competence and independence.

2. Safe and Reliable Payment Systems
Central banks also run or oversee systems like Real-Time Gross Settlement (RTGS), which make large financial transactions final and secure.
These centralized systems reduce risk between parties, support complex financial markets, and are easier to regulate.
However, they can also become choke points—if one fails, the impact can be severe.

Because the system depends on trust, any action taken by these institutions—or by the politicians who influence them—can quickly affect public confidence in money and access to it.

Power Asymmetry and Abrupt Changes in Access or Value

When central institutions use their powers—especially in times of crisis—ordinary people can face sudden losses or lose access to their money. Here are four ways that can happen:

1. Bail-ins and Depositor Losses
After the 2008 financial crisis, the EU created rules (like the Bank Recovery and Resolution Directive, or BRRD) that make shareholders and creditors—not taxpayers—absorb bank losses.
But depositors can be affected too.

• In Cyprus (2013), many depositors saw parts of their savings frozen or converted as part of a bailout.
• It revealed how quickly policy decisions can hit savers.

2. Capital Controls and Withdrawal Limits
In severe financial or political crises, governments may limit withdrawals or block money from leaving the country.

• In Lebanon (post-2019), banks imposed strict limits on how much people could withdraw.
• These unofficial capital controls trapped savings for years and caused widespread unrest.
• It showed how banking and political instability can lead to real-world loss of access for ordinary citizens.

3. Platform Freezes by Private Companies
More payments now go through private digital platforms (like payment apps or online wallets).
These platforms can freeze accounts or hold funds for months due to fraud checks or compliance issues.

• Some users are left without access to their money, even during disputes.
• Lawsuits and investigations have highlighted these practices.
  This is a modern example of how money controlled by private companies is governed more by contracts and private rules than by public law.

4. Extraordinary State Powers Over Money
Governments can also use extraordinary powers to change the rules of money itself.

• A historic example: in 1933, the U.S. government used executive orders to force citizens to surrender their gold.
• This showed that currency systems are ultimately political and can be changed by the state.

These examples are different in scale and cause, but they share a common lesson: Centralized control gives institutions the tools to protect the system—but also the power to take value or access away from individuals.

Mechanisms That Try to Preserve Trust — and Their Limits

Policymakers use several tools to protect depositors and maintain confidence in the financial system. Each helps reduce risk—but also comes with trade-offs:

1. Deposit Insurance

• Programs like the Federal Deposit Insurance Corporation (FDIC) in the U.S. (and similar schemes elsewhere) guarantee small deposits up to a certain limit.
• This helps prevent bank runs by reassuring depositors their money is safe.
• But it can create moral hazard: if people and banks expect protection, they may take more risks or stop monitoring the health of banks closely.

2. Resolution Frameworks (Bail-in Rules)

• Modern systems, like the EU’s Bank Recovery and Resolution Directive (BRRD), aim to handle failing banks by protecting key services while making shareholders and creditors absorb losses instead of taxpayers.
• This helps reduce public costs, but can shock large depositors or investors who assumed their funds were safe.
• These frameworks need clear laws and transparent communication to keep public trust.

3. Regulation and Supervision

• Banks must follow prudential rules, undergo stress tests, and maintain liquidity buffers to stay strong in a crisis.
• But complex regulation can be circumvented—for example, by shifting activity to non-bank institutions or other countries (regulatory arbitrage).
• That’s why global coordination (through bodies like Basel or the Financial Stability Board (FSB)) is essential.

These mechanisms help reduce risks—but they don't remove the need for public trust. The financial system still depends on confidence in legal systems, central institutions, and the rules that govern money and payments.

New Centralization Risks: Fintech, BigTech, and Data Control

The landscape of who controls money is changing. Large tech platforms and non-bank payment providers now move enormous volumes of retail payments. That brings benefits (convenience, inclusion) but new concentration and data-governance risks: 

1. Market Power and Single-Point Control

• BigTech firms and dominant payment platforms can grow rapidly and become critical infrastructure for the financial system.
• Their size gives them leverage over both merchants and consumers.
• Any technical failure or policy change by these platforms can have a major ripple effect.
• Global regulators warn that this growing role must be matched with rules on competition, data access, and financial stability.

2. Surveillance, Censorship, and Private Rules

• When payments flow through private platforms, those companies also control the metadata and the rules.
• They can freeze accounts, deny services, or block transactions based on internal policies—not public law.
• This gives them discretion over who can participate in the economy.
• Regulators are increasingly concerned with consumer protection, privacy, and fair access in this environment.

As BigTech becomes more central to payments, financial power and control over data shift from public institutions to private hands—raising new challenges for regulation, accountability, and trust.

Financial Exclusion: The Unbanked and Underbanked

Another challenge of traditional money is access. Hundreds of millions of people worldwide cannot easily use the formal banking system. According to the World Bank, about 1.7 billion adults globally have no bank account, despite two-thirds owning a mobile phone. Lack of accounts means they cannot safely save money, easily send remittances, or get loans. High fees and requirements (minimum balances, documentation) often bar the poor from banking.

This exclusion has real costs:

1. Access to savings and secure deposits. Without a bank account, individuals cannot safely store money, protect it from theft, or earn interest. Informal methods—cash under the mattress, savings groups, or local money lenders—carry higher risks and lower returns. 
2. Access to credit and capital. Those without formal financial records or collateral face significant barriers to obtaining loans, which limits opportunities for entrepreneurship, investment in education, or home ownership. Microfinance initiatives can partially fill this gap, but they are often limited in scale or accompanied by high interest rates. 
3. Access to payments and remittances. Migrant workers and low-income families face high costs when transferring money. The World Bank estimates that the average global remittance fee is 6–8% per transfer, a significant burden for families relying on small sums of money to meet daily needs. Inadequate access also means that routine transactions—paying bills, receiving wages, or buying goods—are more cumbersome and expensive. 
4. Access in both developing and developed economies. Financial exclusion is not limited to low-income countries. “Banking deserts” in rural areas of wealthy nations, coupled with the rise of gig-economy and cashless wage systems, have left millions underbanked. Lack of access can be as much a structural problem as a financial one, arising from geographic, technological, or regulatory barriers. 

“Financial inclusion is not just an economic issue but a human rights issue.”
— World Bank report, Digital Financial Inclusion

Digital Finance and Partial Solutions

Technology has begun to address some aspects of exclusion. Mobile-money systems, most famously Kenya’s M-Pesa, demonstrate how digital infrastructure can leapfrog traditional banking. Launched in 2007, M-Pesa allows individuals to store value, send payments, and receive funds using a basic mobile phone, without needing a formal bank account. Today, around 72% of Kenyan adults have a mobile-money account, a striking increase from single-digit banking penetration in the early 2000s.

Digital finance can significantly reduce transaction costs, increase the speed of payments, and provide a safer store of value compared with informal cash storage. However, digital solutions still face constraints: 

• Reliance on networks and intermediaries. Mobile wallets depend on telecom coverage and often require partnerships with banks to enable deposits and withdrawals. Service interruptions or network failures can cut off access entirely. 
• Regulatory and infrastructure gaps. Many low-income countries lack comprehensive frameworks for digital payments, consumer protection, or cybersecurity, which limits the scale and reliability of mobile finance. 
• Inequality within countries. Even where mobile finance is available, segments of the population—such as women, the elderly, or rural residents—may face literacy, mobility, or cultural barriers that inhibit adoption. 

The lesson is clear: financial inclusion is as much about infrastructure, governance, and institutional design as it is about technology. While mobile and digital platforms have reduced barriers in some regions, a significant portion of the global population remains effectively excluded from the benefits of formal monetary systems. 

Conclusion: The Three Core Challenges of Modern Money

Across these three areas—inflation and currency depreciation, centralization and trust, and financial exclusion—modern monetary systems face persistent and interconnected challenges. 

1. Inflation and depreciation threaten money’s fundamental roles as a store of value and unit of account. Even moderate inflation can erode savings and distort planning, while hyperinflation can devastate economies, destroy trust, and trigger social and political instability. 
2. Centralization and trust concentrate power in governments, central banks, and large financial institutions. While centralization enables monetary policy, efficient settlement, and economic stability, it also makes ordinary users dependent on institutions whose decisions or failures can restrict access, confiscate value, or create systemic shocks. 
3. Financial exclusion highlights that access is uneven. Even if money is stable and the system is trusted, millions of people worldwide remain unbanked or underbanked, limiting their ability to save securely, transact efficiently, or access credit and remittances. Digital technologies offer solutions, but infrastructural, regulatory, and social barriers persist. 

Taken together, these three challenges illustrate that money is not just a technical instrument, but a socially and institutionally mediated system. Its effectiveness depends on stability, governance, and accessibility. For money to fully perform its functions—as a medium of exchange, store of value, and unit of account—policymakers, financial institutions, and innovators must address not only the mechanics of issuance and monetary policy but also trust, inclusion, and resilience. Money works best when it is stable, trusted, and universally accessible; any breakdown in these areas undermines both economic efficiency and social well-being.