Tuesday, April 7, 2020

Rescuing the economy: Where money comes from, and what it does

I've noticed a number of articles and comments around the blogosphere talking about government economic relief programs for the coronavirus pandemic.  Many of them claim that the government is "printing money" to deal with this crisis, and that this will inevitably bounce back on the "real" economy when the crisis is over.  In one sense they're right, but in another they're wrong.  Money itself isn't the problem - it's how it's generated and used.

In order to clarify the situation, I thought two 2014 articles in Adobe Acrobat format from the Bank of England might be useful.  They explain, in clear and simple terms for non-economists, how money is used, and how it's "created" in a modern banking system.  They're written from a British perspective, but their principles apply to all modern economies.  Whenever they mention the Bank of England, just think of the US Federal Reserve, and you'll get the idea.

The first article is titled "Money in the modern economy:  an introduction".

  • Money is essential to the workings of a modern economy, but its nature has varied substantially over time. This article provides an introduction to what money is today.
  • 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 second article is titled "Money creation in the modern economy".

  • This article explains how the majority of money in the modern economy is created by commercial banks making loans.
  • Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits.
  • The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.

I highly recommend reading both articles.  They'll give you a much clearer understanding of where money comes from in our modern economy, and how it's being used to relieve some of the stresses of the coronavirus pandemic.

Of course, creating so much "new money" will impose economic stresses of its own.  It's a matter of relieving the primary stresses (caused by the impact of the pandemic on our economy) as quickly as possible, and worrying about the secondary stresses (caused by the sudden creation of so much "new money") later, because there's no time to do so now.  In one sense, it's a "damned if you do, damned if you don't" approach.  That's not necessarily very comforting, but it helps to understand why these steps are being undertaken - and how.



mark leigh said...

The Federal Reserve, debasing the currency since it's inception. Inflation is an increase in the money supply the rise in prices is the result of the increase in the money supply distorting the supply and demand equation. Remember this inflation is caused by increasing the amount of money available to purchase goods and services. The Fed does not fight inflation it causes it. This might not be a big problem for after all it's just a little equation fiddling. The problem arises because the new money doesn't go to everyone at the same time in the same ratio. Banks get the new money and lend it out, producers borrow the money and buy materials and labor. With money reduced in value by being inflated in volume, from suppliers who sell at old prices while the money they are accepting is unknown to them worth less. This resolves soon as prices shift as the market adjusts to the new price levels but it takes time and the further down the chain you are the more you are forced to take lower values for what you sell. It is in effect a theft, a very roundabout and widely distributed theft but theft it is. Governments have been debasing the currency to steal from their citizens ever since coin clipping and purity altering were invented thousands of years ago. It was immoral then and it is immoral now.

McChuck said...

Modern money is theft by banks and governments. Nothing more and nothing less. They both create currency out of nothing, but demand to be payed back with earned, "real" money, with interest. Part of the interest payment is inflation, which is a tax on savings.

Just like the government, the banks always win. He who has the gold (or can legally create currency), makes the rules.

Banks hate counterfeiters just as much as the government does, and for the same reasons. They're cutting in on their racket, and making people think about how the sausage is made.

Tom Grey said...

Damned if you don't DO IT NOW,
but only "maybe damned", sometime in the future, if you Do It Now.

Almost certainly AFTER the next election.

That's a problem with democracy.

Better to give more poor people more money they didn't earn, and let them avoid/ reduce their poverty problems. But most of the gov't give-away is to the rich owners of capital, not the poor who don't own much. (Tho whose lifestyles would lead many to think they don't deserve to own much.)