Study Notes: Money and Monetary Creation - S.E.S. Grade 11
Historical Context and Definition of Money
The Myth of Linear Evolution: * Historically, there has been no linear evolution progressing strictly from barter to money. * It is inaccurate to state that human societies simply moved from one to the other in a chronological sequence.
Barter (Le Troc): * Defined as the direct exchange of one good or service for another good or service. * Barter has been utilized at various points throughout history, including contemporary history during specific periods such as wartime.
The Early Appearance of Money: * Money appeared very early in human history, coexisting with other forms of exchange rather than merely replacing them.
The Forms and Dematerialization of Money
The Concept of Dematerialization: * Dematerialization refers to the progressive transition from money with physical/material supports to forms of money that have no physical shape. * This transition moves from: * Commodity Money (Monnaie marchandise) * Metallic Money (Monnaie métallique) * Fiduciary Money (Monnaie fiduciaire) * The end result is money existing solely as book entries (writings) on bank accounts.
Current Monetary Composition in France and the Eurozone: * Fiduciary Money: Less than of the money in circulation consists of banknotes and coins issued by the Central Bank. * Scriptural Money (Monnaie scripturale): The remaining consists of deposits managed by commercial banks. This is dematerialized money held in bank accounts.
The Functions of Money
Economic Functions: * Unit of Account (Unité de compte): Money serves as a standard measure that allows for the comparison of the value of different goods. * Intermediate of Exchange (Intermédiaire des échanges): Money acts as a medium that allows for the acquisition of any good or service, facilitating trade without the need for the double coincidence of wants required in barter. * Store of Value (Instrument de réserve de valeur): Money can be kept or saved while retaining its value over time, allowing for future purchasing power.
Social Functions: * Trust (Confiance): The use of money rests entirely on trust—trust in the value it represents and trust in the institution that issues it. * Social Cohesion: Money acts as an instrument of social cohesion by creating links between individuals and groups. * Comparison to Language: In a social sense, money is comparable to language because it allows for the unification of society.
The Process of Monetary Creation
The Role of Commercial Banks: * Monetary creation is primarily the result of commercial banks, specifically when they grant credit to economic agents. * The "Loans Make Deposits" Formula: The process is summarized by the phrase "les crédits font les dépôts" (credits make deposits). When a bank grants a loan, it creates the money it lends by writing the sum into the borrower's account.
The Mechanism of Credit: * When a credit is granted, the borrower provides a promise of reimbursement. * This promise represents a claim (créance) held by the bank against the borrower. * In exchange, the bank records the corresponding amount on the borrower's account as scriptural money.
Types of Claims and Money Creation: * Claims on the Economy (Créances sur l’économie): This refers to credits granted to households (for consumption) and businesses (for investment). These credits support demand and favor economic growth. * Claims on the Treasury (Créances sur le Trésor): This term is used when banks grant credit to the State. * Foreign Exchange Operations: When non-residents of France (or the Eurozone) require Euros in exchange for their own currency, banks effectively create scriptural money in Euros.
Interbank Payments and Liquidity: * Once money is created and deposited, the borrower can use it to withdraw banknotes or make payments to other economic agents. * If the recipient of a payment has an account at a different bank, a payment inter-bank (paiement interbancaire) must occur. * To perform these compensations and provide clients with banknotes, every commercial bank must maintain a sufficiently funded account at the Central Bank.
The Role of the Central Bank
Management of Monetary Circulation: * The Central Bank manages the quantity of money to ensure there is neither too much (to avoid inflation) nor too little (to avoid deflation).
Functions as the "Bank of Banks": * Monopoly of Issuance: The Central Bank has the exclusive right to issue fiduciary money (banknotes). * Management of Foreign Exchange Reserves: It manages the country's foreign currency reserves. Commercial banks turn to the Central Bank to buy or sell foreign currencies when they cannot balance these operations on the exchange market. * Supply of Liquidity: It provides second-tier (commercial) banks with liquidity, using this "closing" function of the monetary system to influence the total money supply according to its monetary policy objectives. * Lender of Last Resort (Prêteur en dernier ressort): In the event of a severe liquidity shortage (e.g., following the failure of a major institution), the Central Bank intervenes to prevent a wider crisis.
Monetary Policy and Interest Rates
Key Interest Rates (Taux d’intérêt directeurs): * The Central Bank conducts monetary policy by setting these rates. * These rates determine the cost at which commercial banks borrow from each other on the money market, which in turn dictates the interest rates they offer to other economic actors (households and businesses).
Objectives of the European Central Bank (BCE): * The primary objective in the Eurozone is Price Stability. * This is defined as an annual price increase (inflation) that is close to but below .
Monetary Policy Actions: * High Inflation Scenario: If inflation exceeds the threshold, the ECB generally increases its key interest rates. This makes credit more expensive, which slows down demand and the rise in prices. However, this action also degrades economic activity and growth. * Low Inflation Scenario: If the inflation rate is too low, the ECB lowers its key interest rates to make credit cheaper and stimulate the economy.