Learn from The Best Knowledge Videos Collection on How Money is Made and Why We can’t print enough Money to pay off the Debt?
Public Facts about Money Creation
Money creation is the process by which the money supply of a country, or of an economic or monetary region, is increased. In most modern economies, money creation is controlled by the central banks. Money issued by central banks is termed base money. Central banks can increase the quantity of base money directly, by engaging in open market operations.
However, the majority of the money supply is created by the commercial banking system in the form of bank deposits. Bank loans issued by commercial banks that practice fractional reserve banking expands the quantity of broad money to more than the original amount of base money issued by the central bank.
Central banks monitor the amount of money in the economy by measuring monetary aggregates (termed broad money), consisting of cash and bank deposits. Money creation occurs when the quantity of monetary aggregates increase.Governmental authorities, including central banks and other bank regulators, can use policies such as reserve requirements and capital adequacy ratios to influence the amount of broad money created by commercial banks.
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The money supply (or money stock) refers to the total volume of currency held by the public at a particular point in time. There are several ways to define “money”, but standard measures usually include currency in circulation (i.e. physical cash) and demand deposits (depositors’ easily accessed assets on the books of financial institutions). The central bank of a country may use a definition of what constitutes legal tender for its purposes.
Money supply data is recorded and published, usually by a government agency or the central bank of the country. Public and private sector analysts monitor changes in the money supply because of the belief that such changes affect the price levels of securities, inflation, the exchange rates, and the business cycle.The relationship between money and prices has historically been associated with the quantity theory of money.
Everything You Need to Know How Money is Created?
There is some empirical evidence of a direct relationship between the growth of the money supply and long-term price inflation, at least for rapid increases in the amount of money in the economy.For example, a country such as Zimbabwe which saw extremely rapid increases in its money supply also saw extremely rapid increases in prices (hyperinflation). This is one reason for the reliance on monetary policy as a means of controlling inflation
Why can’t we print money to pay off Debt ?
Public Facts about Money Supply and Monetary exchange equation
The money supply is important because it is linked to inflation by the equation of exchange in an equation proposed by Irving Fisher in 1911.
M times V=P times Q
where M is the total dollars in the nation’s money supply, V is the number of times per year each dollar is spent (velocity of money), P is the average price of all the goods and services sold during the year, Q is the quantity of assets, goods and services sold during the year.
In mathematical terms, this equation is an identity which is true by definition rather than describing economic behaviour. That is, velocity is defined by the values of the other three variables. Unlike the other terms, the velocity of money has no independent measure and can only be estimated by dividing PQ by M.
Some adherents of the quantity theory of money assume that the velocity of money is stable and predictable, being determined mostly by financial institutions. If that assumption is valid then changes in M can be used to predict changes in PQ.
If not, then a model of V is required in order for the equation of exchange to be useful as a macroeconomics model or as a predictor of prices. Most macroeconomists replace the equation of exchange with equations for the demand for money which describe more regular and predictable economic behaviour.
However, predictability (or the lack thereof) of the velocity of money is equivalent to predictability (or the lack thereof) of the demand for money (since in equilibrium real money demand is simply Q / V ).
Why can’t Governments print an Unlimited Amount of Money?
Either way, this unpredictability made policy-makers at the Federal Reserve rely less on the money supply in steering the U.S. economy. Instead, the policy focus has shifted to interest rates such as the fed funds rate. In practice, macroeconomists almost always use real GDP to define Q, omitting the role of all transactions except for those involving newly produced goods and services (i.e., consumption goods, investment goods, government-purchased goods, and exports). But the original quantity theory of money did not follow this practice: PQ was the monetary value of all new transactions, whether of real goods and services or of paper assets.
The monetary value of assets, goods, and services sold during the year could be grossly estimated using nominal GDP back in the 1960s. This is not the case anymore because of the dramatic rise of the number of financial transactions relative to that of real transactions up until 2008. That is, the total value of transactions (including purchases of paper assets) rose relative to nominal GDP (which excludes those purchases).
Ignoring the effects of monetary growth on real purchases and velocity, this suggests that the growth of the money supply may cause different kinds of inflation at different times. For example, rises in the U.S. money supplies between the 1970s and the present encouraged first a rise in the inflation rate for newly-produced goods and services (“inflation” as usually defined) in the 1970s and then asset-price inflation in later decades: it may have encouraged a stock market boom in the 1980s and 1990s and then, after 2001, a rise in home prices, i.e., the famous housing bubble.
This story, of course, assumes that the amounts of money were the causes of these different types of inflation rather than being endogenous results of the economy’s dynamics. When home prices went down, the Federal Reserve kept its loose monetary policy and lowered interest rates; the attempt to slow price declines in one asset class, e.g. real estate, may well have caused prices in other asset classes to rise, e.g. commodities.
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