Creating Money
In the days of commodity money such as gold, the only ways to create more money were either to mine it, convert it from other uses, trade for it (that is to export more than you import) or steal it. The Conquistadors very successfully used the last method to increase the money stock of Spain. In fact they were so successful that the resultant increase in the money supply is thought by some (incorrectly IMHO) to have caused high inflation which wrecked the Spanish economy.
There are 3 main ways that fiat money is created: by Governments literally printing cash, via a process now known as ‘quantitative easing’ and by banks by a process known as fractional reserve banking. It is also possible to add to the money supply by exporting more than you import but it's quite complex and this is meant to be a simple examination of money.
Pretty much all Governments print more cash than they destroy because as the output of an economy rises, more money is required to buy those things. Sometimes Governments get a little carried away and print too much and the outcome of that can be seen in the monetary experiment in Zimbabwe.
From Zimbabwe we can see that more money chasing the same number of goods and services leads to the goods and services becoming more expensive. The Zanu PF Government was apparently hoping that printing money would lead to more output, the logic being that total money divided by prices equals output so if you free the money stock to expand, you free output to expand if you can keep prices the same by making price rises illegal.
I think it’s reasonable to say that experiment has failed.
Another way Governments can increase the amount of money in the economy is by a process known as quantitative easing (QE).
When output is falling, Central Banks often cut interest rates to try to stimulate people and businesses to borrow to consume and invest. At certain times, that doesn’t work either because interest rates are so low they can’t be cut further or because banks simply don’t have the money to lend, perhaps because they have lost money elsewhere on bad loans or other investments.
In this case, the Central Bank might resort to QE. The mechanism is fairly simple. The Central Bank creates money, usually electronically rather than by physically printing notes but it amounts to the same thing. The Central Bank then uses that money to buy up Government or other debt in the market. That has 2 impacts. Firstly by selling debt, the banks have more cash which they are able to lend. Secondly by increasing the demand for debt, its price rises. The price of debt rising is the same as interest rates falling so it makes borrowing cheaper.
The last way fiat money is created is via the banking system and a process known as fractional banking. I will cover this in the next article mostly because it's a bit mathematical and people sometimes find that intimidating. Also it stands alone as a topic quite nicely.
There are 3 main ways that fiat money is created: by Governments literally printing cash, via a process now known as ‘quantitative easing’ and by banks by a process known as fractional reserve banking. It is also possible to add to the money supply by exporting more than you import but it's quite complex and this is meant to be a simple examination of money.
Pretty much all Governments print more cash than they destroy because as the output of an economy rises, more money is required to buy those things. Sometimes Governments get a little carried away and print too much and the outcome of that can be seen in the monetary experiment in Zimbabwe.
From Zimbabwe we can see that more money chasing the same number of goods and services leads to the goods and services becoming more expensive. The Zanu PF Government was apparently hoping that printing money would lead to more output, the logic being that total money divided by prices equals output so if you free the money stock to expand, you free output to expand if you can keep prices the same by making price rises illegal.
I think it’s reasonable to say that experiment has failed.
Another way Governments can increase the amount of money in the economy is by a process known as quantitative easing (QE).
When output is falling, Central Banks often cut interest rates to try to stimulate people and businesses to borrow to consume and invest. At certain times, that doesn’t work either because interest rates are so low they can’t be cut further or because banks simply don’t have the money to lend, perhaps because they have lost money elsewhere on bad loans or other investments.
In this case, the Central Bank might resort to QE. The mechanism is fairly simple. The Central Bank creates money, usually electronically rather than by physically printing notes but it amounts to the same thing. The Central Bank then uses that money to buy up Government or other debt in the market. That has 2 impacts. Firstly by selling debt, the banks have more cash which they are able to lend. Secondly by increasing the demand for debt, its price rises. The price of debt rising is the same as interest rates falling so it makes borrowing cheaper.
The last way fiat money is created is via the banking system and a process known as fractional banking. I will cover this in the next article mostly because it's a bit mathematical and people sometimes find that intimidating. Also it stands alone as a topic quite nicely.
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