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, 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.
The following diagram explains why we have money in the modern economy:
Watch the following video for a summary of money in the economy: