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3) The three limits of money creation
Banks need to create money during periods of high activity because people consume more (example: Christmas.) Banks are therefore asked to create bank money. Money creation is not regular, it is cyclical.
Initially, the currency is scriptural then it is converted into currency because people buy with checks or with the credit card but also with coins and notes.
There is a limit to the power of monetary creation of banks because they do not create fiat money. The banks do not have the banknotes that allow the conversion of book money, so the conversion of book money into banknotes is a limit to money creation. This poses a problem for banks because the quantity of banknotes that they can have is decided by the central bank within the framework of the refinancing operations, ie the operation by which the bank obtains the monetary base.
This limits the power of banks. The banknotes are central bank money or monetary base. The monetary base will be used to settle the debt (central bank money and banknotes)
What are the three limits of money creation?
These three limits are:
-the banks' need for banknotes (conversion of bank money into fiduciary money.) This is a limit because the banks create bank money and
no money in the money.
-the central bank controls the monetary base. If the central bank wants to disadvantage money creation, it lowers the monetary base and / or makes it more expensive.
- compensation: it is the fact that banks owe money to each other. This is a limit because to repay their debts the banks have to use the
monetary base, the only monetary form accepted by all banks.
Banks create money, they need the monetary base. MFIs therefore have to obtain money. By controlling access to the monetary base, the central bank controls monetary creation within the framework of the Open Market policy. It intervenes in the money market to act on the monetary base, therefore on refinancing and therefore indirectly on money creation.
What is the money market?
The money market is the market where we exchange the monetary base (we will see that the money market also includes a compartment where financial assets are exchanged). The monetary base is either offered by the central bank and MFIs, but also requested by the central bank or MFIs. The central bank offers the monetary base when it wants the other banks to have one. So when she wants to promote money creation, she is a good seller and vice versa.
What is the interest rate on the money market?
The interest rate on the money market is the price at which the monetary base is exchanged on the money market.
4) The effects of money creation on growth
Growth and money supply
What is the role of money? What opinion about the amount of money in optimal circulation (the best possible)
For liberal economists
Passive role of money, it is the intermediary of the exchanges
Limiting creation with a high interest rate
For Keynesian economists
Active role of money, it can be desired for itself
You have to create money with a low interest rate
There are therefore two different conceptions of money: that of liberal economists and that of Keynesian economists.
For the liberals: money cannot promote growth. It is not a store of value. Money is a veil. It does not contradict JB Say's law that supply creates its own demand. Money is not a store of value. The quantity of money must evolve according to production otherwise there will be inflation.
For Keynesians: money is desired by itself, it serves to save but it can promote economic growth, consumption, production. It is necessary creating, its necessary to create
of money, it is a hope that there is more demand, more growth, more production.
Growth and interest rates
The central bank wants to slow down money creation -> Increase in the interest rate on the money market -> Increase in the interest rate offered by banks -> If the interest rate increases then credit will decrease and that will slows down demand and therefore economic growth
The central bank wishes to promote money creation -> Decrease in the money market interest rate -> Decrease in the interest rate offered by banks -> Increase in demand for credit -> Positive effect on investment and on household consumption -> Positive effect on growth.