The Life Cycle of Money
6 hours ago
- #monetary policy
- #fiscal deficits
- #central banking
- Money is fundamentally a claim on the state or financial intermediaries, existing in three forms: base money (central bank liabilities), broad money (includes bank deposits), and credit money (claims on private entities).
- Money creation involves loans creating deposits in commercial banks, with reserves following as needed, not the other way around.
- Government deficits inject net financial assets into the private sector, increasing private sector deposits when the government spends more than it taxes.
- International trade leads to dollar outflows, with foreign central banks accumulating dollar reserves, often invested in U.S. Treasuries for safety and liquidity.
- The Federal Reserve can expand or contract the monetary base through open market operations, quantitative easing (QE), or quantitative tightening (QT), influencing reserves and interest rates.
- Commercial banks create money through lending, constrained by capital adequacy and regulatory requirements rather than reserve availability.
- Payment and settlement systems like Fedwire and ACH facilitate the movement of money without creating it, ensuring liquidity and finality in transactions.
- Foreign central banks intervene in currency markets to stabilize exchange rates, accumulating dollar reserves which are often reinvested in U.S. Treasuries, reinforcing dollar dominance.
- The money system is vulnerable to liquidity and solvency crises, with stabilizers like automatic fiscal policies and Federal Reserve interventions mitigating downturns.
- The lifecycle of money—from sovereign issuance to global recycling—highlights its role as an institutional arrangement dependent on legal frameworks, public trust, and economic productivity.