Original link: https://hijiangtao.github.io/2022/05/29/Monetary-System-Notes/
(1) What is currency
Before the broad form of money appeared, people achieved the purpose of transaction through barter. This economy requires two-way consistency of demand, that is, each has exactly the goods or services that the other wants.
With the development of production, the content and scope of exchange continue to increase and expand. This kind of simple barter is becoming less and less suitable for the needs of human life and development, so money, a well-known “currency”, was born.
Currency can be roughly divided into two categories: commodity currency and legal tender:
- Commodity money : money itself has intrinsic value, such as gold;
- Fiat currency : currency determined by governmental decree, which has no intrinsic value;
The amount of money circulating in the economy is called money stock , which includes currency (paper money and coins held in hands), demand deposits, etc.
Currency is a set of assets in an economy that people often use to buy goods and services from each other. It has multiple functions: a medium of exchange, a unit of account, and a store of value.
In the economy, liquidity is usually used to describe the ease with which an asset can be converted into a medium of exchange in the economy. For example, the liquidity of currency is the strongest, while real estate and artwork are relatively weak. When people decide to hold their wealth in different forms, they struggle to find a balance between liquidity and store of value. Money is great for liquidity, but not so great as a store of value.
(2) Banks and money supply
Who can send money, or affect the money supply, the first thing everyone thinks of is the bank.
As an intermediary between borrowers and lenders of money capital, banks pool the idle money capital in the society in the form of deposits, and then lend them to other enterprises. However, the bank’s loanable funds are also limited, and it is not the endless money that the public thinks. This is related to a noun, the deposit reserve ratio.
Bank reserves are deposits that banks take but do not lend, and if the bank holds all deposits in full reserves, the bank does not affect the money supply. At this time, the bank’s reserve ratio is 100%.
If a bank lends out a portion of its deposits for interest, the reserve ratio is less than 1. This type of bank is also called a fractional reserve bank.
The reserve ratio is set by government regulation in conjunction with banking policy. After some of the deposits are lent out, the increased amount of money exists in the form of the lender’s liability, which increases the amount of money as a whole. The amount of money that can ultimately be generated through reserves is equal to the inverse of the reserve multiplied by the reserve ratio. This factor is also known as the money multiplier , which is the amount of money generated by 1 unit of reserves.
(3) Central Bank
The central bank is the highest financial authority of a country. It is developed from general commercial banks. It has the basic characteristics of a bank and is special. It is the highest authority of a country’s currency and finance.
The central bank of the United States is a private institution, the Federal Reserve System of the United States. The three main functions of the Federal Reserve are:
- Regulate banks to ensure they comply with federal laws designed to promote safe and sound banking;
- Acting as the bank’s bank, making loans to the bank and acting as the lender of last resort;
- To implement monetary policy by controlling the money supply;
Among these three functions, the most important means for the Fed to affect the money supply is to affect the money supply multiplier by affecting the amount of reserves and the reserve ratio:
- Affect the amount of reserves : You can increase and decrease the money supply through open market operations, that is, openly buying and selling government bonds; you can also issue loans to banks through the discount window, and the interest rate on loans is called the discount rate. Raising and lowering the discount rate reduces and encourages borrowing from the Fed, respectively, thereby reducing and increasing the money supply
- Affecting the reserve ratio : It is possible to change the statutory reserve requirement for the minimum amount of reserves held by banks. Since many banks hold excess reserves, this method is not used much now; it can also be used to pay interest on reserves, that is, in the form of Fed deposits. Interest is paid to the bank when the reserve is held in this way.
China also has the same institution, the People’s Bank of China. Decisions on annual money supply, interest rates, exchange rates or other important monetary policy matters are organized and formulated by the People’s Bank of China.
The People’s Bank of China has three main types of open market business, including repurchase transactions, spot bond transactions and issuance of central bank bills :
- Among them, repurchase transactions are divided into two types: “positive repurchase” and “reverse repurchase”. Positive repurchase refers to the sale of securities by the People’s Bank of China to primary dealers and an agreement to buy back the securities on a specific date in the future. Trading behavior, positive repurchase is the operation of the central bank to reduce liquidity from the market, and the positive repo is the operation of the central bank to increase liquidity to the market; reverse repo is the People’s Bank of China to purchase securities from primary dealers, and A transaction that agrees to sell securities to a primary dealer on a specific date in the future. A reverse repo is an operation where the central bank puts liquidity into the market, and a reverse repo is an operation where the central bank withdraws liquidity from the market when it expires.
- There are two types of spot bond transactions: “spot bond buyout” and “spot bond sellout”. The former is for the central bank to directly buy bonds from the secondary market, and the base currency is put in one-time; the latter is for the central bank to directly sell and hold bonds. , to withdraw the base currency at one time.
- “Central bank bills” are short-term bonds issued by the People’s Bank of China. The central bank can withdraw base currency by issuing central bank bills, and the maturity of central bank bills is reflected in the issuance of base currency.
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