“Money is a little like an airplane – marvellous when it works, frustrating when it is immobilised, and tragic when it crashes.” Money is one of man’s great inventions, and it is a crucial part of the pervasive framework of a society organised along the lines of free markets – characterised by private property, the division of labour and free trade. It has become common practise to define money as the universally accepted means of exchange.
“(…) a world monetary system has emerged that has no historical precedent: a system in which every major currency in the world is, directly or indirectly, on an irredeemable paper money standard (…). The ultimate consequences of this development are shrouded in uncertainty.”
– Milton Friedman (1994), Money Mischief, p. 249.
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Notes
- 1.
Harriss (1961), p. 3.
- 2.
Mises (1996), p. 401.
- 3.
Mises (1981), p. 45.
- 4.
Mises (1996), p. 410.
- 5.
In this context see What has Government Done to Our Money? first published in 1963 by the historian, philosopher and economist Murray N. Rothbard (2005).
- 6.
Hayek (1976), p. 192.
- 7.
Mises (1981), p. 454.
- 8.
Ibid, p. 491.
- 9.
For an excellent survey about the performance of the gold standard in different historical periods see Eichengreen and Flandreau (1997).
- 10.
- 11.
The California gold rush in 1848 is a case in point. The newly produced gold increased the US money supply, which then raised domestic expenditures, nominal income, and ultimately, the price level.
- 12.
On the theory of commodity money, see, for instance, Friedman (1953).
- 13.
Milton Friedman estimated the cost of maintaining a full gold coin standard for the US in 1960 to be more than 2.5 percent of GNP. In 1990 this cost would have been US$137bn (Friedman, 1959). Initially, Friedman proposed to replace the gold standard by a “less costly” paper money standard bound by a strict money growth rule (Friedman, 1986, 1987). In the 1980s, he changed his mind, reconsidered the costs of inflation in the absence of a strict rule, and called for abolishing the Federal Reserve System (though not replacing it with a gold standard).
- 14.
For an excellent survey of the main drawbacks of the gold standard see, for instance, Krugman and Obstfeld (2006), p. 472.
- 15.
Various opinions on Asian exchange rate and reserves policies are examined in ECB (2007), and the costs and benefits of currency undervaluation are also discussed.
- 16.
Banknotes issued by the Fed are IOUs of the Fed to the bearer. IOU is an abbreviation of the phrase “I owe you". An IOU in the business community is a legally binding agreement between a borrower and a lender. Unlike most liabilities, however, Fed banknotes promise to pay back the bearer solely with Fed banknotes. For instance, if someone hands over a $100 bill to the Federal Reserve and demands payment, he will receive two $50s, five $20s, ten $10s, or one hundred $1 bills. That is the Fed pays off IOUs with other IOUs.
- 17.
With a base money supply of US$60 and a minimum reserve ratio of 2%, banks can, in a first step, increase credit and money supply by US$3000, respectively (that is US$60 divided by 0.02). If, in a second step, banks make their clients shifting, say, sight deposits of US$2000 into longer-term liabilities (which are not subject to minimum reserves), base money in the amount of US$40 can be freed up; this allows an additional credit and money creation of US$2000.
- 18.
The 1988 Basle Accord (Basle I) is the globally agreed standard by which supervisors calculate and set capital charges for internationally active banks. The Accord sets out rules which require firms to hold a minimum of 8% capital to mitigate against credit and market risk. Building on Basle I, the new Basle Framework for the International Convergence of Capital Measurement and Capital Standards (Basel II) came into force in Europe at the end of 2006. The key objective of the new capital adequacy framework is to bring in line banks’ capital requirements more closely with the actually incurred risk than in the past and to take account of recent innovations in the financial markets as well as in institutions’ risk management.
- 19.
Of course, authorities could relax the capital requirement. However, such a measure would, as a rule, be effective only if banks’ write-offs do not exceed their equity capital. What is more, a lowering of the capital requirement might erode the public’s confidence in the financial health of the banking sector.
- 20.
The main focus here is the structural liquidity deficit position of the euro area banking system (i.e. its position vis-à-vis the Eurosystem net of monetary policy operations). See ECB (1999), p. 41.
- 21.
The Fed allows banks to satisfy its reserve requirements with currency held on the bank’s premises (vault cash). Each depository institution’s level of applied vault cash in a maintenance period is calculated as the average value of the vault cash it held during an earlier computation period, up to the level of its reserve requirements. Thus, the level of applied vault cash is lagged and known prior to the start of each maintenance period. Applied vault cash is included in official measures of reserves.
- 22.
- 23.
- 24.
- 25.
Heterodox economists believe that the profit motive, as well as profit-seeking financial innovations, plays a role in the creation of money by the banking system. In a survey paper on endogenous money - structuralists versus horizontalists, Wray (2007) concludes that the central bank’s influence on the quantity of money is indirect and unpredictable, and therefore should be of little interest to economists.
- 26.
- 27.
What about the central bank’s official interest rate, then? For most mainstream economists, the central bank reaction function – when modelled as a Taylor rule (Taylor, 1993) – is based on a target rate of inflation and a target rate of output growth. But once these targets are fixed, realized inflation and growth are the dominant endogenous variables in the central bank reaction function. One could say that the only autonomy left to the central bank is to decide about the timing of the change in the interest rate.
- 28.
The prominent role of M3 in the ECB strategy de facto ended with the bank’s strategy revision from May 2003 (ECB 2003, p. 79). The stock of M3 was downgraded from an information/intermediate (target) variable of monetary policy to a mere cross-checking variable.
- 29.
In accordance with aggregation theory, a monetary aggregate is defined over a weakly separable block in the utility function. This definition is rarely implemented because tests for blockwise weak separability are biased towards rejection; a single rejection in the data renders the formation of a separable group impossible. For a discussion of separability tests and applications to US monetary data, see Swofford and Whitney (1986, 1987, 1988, 1994).
- 30.
The term Divisia index is used refers to the Törnqvist-Theil discrete time approximation to the continuous time index suggested by Divisia (1925).
- 31.
Aggregation of real monetary assets is equivalent to aggregating nominal assets and deflating the monetary services index afterwards (see Anderson, Jones, & Nesmith, 1997b). For calculating a Divisia index for the euro area see Wesche (1997).
- 32.
See Barnett, Offenbacher and Spindt (1984), p. 1052.
- 33.
Gaab and Mullineux (1996) mention further problems posed by calculating Divisia indices.
- 34.
In this context it should be noted that if banks’ working balances exceed the required reserve holdings for deposits with longer maturities, banks have an incentive to induce non-banks to shift sight deposits to longer-term deposits. If, for instance, the reserve ratios for sight and time deposits are equal, and if the reserve ratio is smaller than the working balance ratio for sight deposits w, that is \(r_T = r_S < w\), it is profitable for banks to induce non-banks to shift from sight into time deposits. By doing so, excess reserves rise.
- 35.
See in this context Chapter 4 of this book.
- 36.
For instance, in the German reunification period, ongoing uncertainty about property rights led to a marked delay of investment activity. In such an environment, non-banks tended to park their money balances on short-term bank deposits. As the latter was included in the definition of the German stock of money, the stock of M3 was bloated up by a considerable margin, misleadingly indicating an expansionary monetary policy. See Westerheide (1995), p. 115.
- 37.
Using market exchange rates to convert local currency money may impart some volatility to the global monetary aggregate, so that using (say) a moving average would reduce this effect. Alternatively, one may use relative PPP at a given point in time.
- 38.
Among international central banks, the ECB explicitly addressed the issue of rising global liquidity in January 2004 for the first time (as far as we are informed).
- 39.
These and the following explanations are taken from the web site of the US Federal Reserve Board, Washington DC, and The Federal Reserve System (2005), Purposes and Functions, Washington DC.
- 40.
As of July 2005, there were 12 governors in the Governing Council. In 2008, this number has grown to a total of 15 governors. With the Slovakia NCB governor knocking on the area’s door as the potential 16th member.
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Belke, A., Polleit, T. (2009). Money and Credit Supply. In: Monetary Economics in Globalised Financial Markets. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-540-71003-5_1
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