FIAT is a Latin word meaning “let it be done.” In the context of economics and monetary policy, it refers to the concept that currency derives its value from government decree or legal tender laws rather than from a commodity backing, such as gold or silver.
Key points about fiat currency:
- Government-issued: Fiat currencies are issued by a government or central bank.
- Legal tender: They are legal tender within a specific jurisdiction, meaning that businesses and individuals must accept them as payment for goods and services.
- No intrinsic value: Fiat currencies have no inherent value beyond their use as a medium of exchange.
- Value based on trust: The value of a fiat currency is based on trust in the issuing authority and the stability of the economy.
- Inflationary potential: Fiat currencies are susceptible to inflation, which occurs when the supply of money increases faster than the economy’s ability to produce goods and services.
Examples of fiat currencies:
- U.S. dollar (USD)
- Euro (EUR)
- British pound sterling (GBP)
- Japanese yen (JPY)
- Swiss franc (CHF)
In contrast to fiat currencies, commodity currencies and cryptocurrencies:
- Have intrinsic value based on the underlying commodity (e.g., gold, silver).
- Are not issued by governments.
- Are often used as a store of value.
The transition from commodity-backed currencies to fiat currencies was a significant development in economic history, enabling governments to have greater control over monetary policy and stimulate economic growth. However, it also introduced new risks, such as inflation and the potential for economic instability.