At the latest with the global financial crisis, the interest in the functioning of our monetary system was also awakened in the general public. For the layman it is hardly comprehensible how this development could have come about. However, after the bursting of the American real estate bubble, it has also become clear within the economic guild that the fundamental interrelationships of a monetary economy had been neglected for too long. has set itself the goal of preparing these fundamental connections as simply as possible. to provide a low-threshold introduction also for laymen. For this purpose seven "modules" are available, which are built up on each other. At the end of each module there are some quizzes to test what you have learned. Before we get started, the structure of this blog will be explained in the following.

"Money" can, depending on the point of view or. the nature of the question taking different forms. In order to avoid misunderstandings, we will first have to define important terms related to money, since it is essential for the understanding of monetary relations to deal very precisely with those very terms. The introductory section therefore starts with the different forms as well as the defining properties of money. We will have to conclude that there is no one true definition of money, but that different forms of money offer advantages and disadvantages depending on the question under investigation.

In addition, it is helpful to know some Fundamentals of Accounting To understand, since money is ultimately based on the concept of double-entry bookkeeping. The second module (accounting) will therefore provide the basics needed to understand money. To keep this brief explanation from being too dry, these basics are explained directly using the example of money creation by private banks.

The third section (Money and wealth) will finally point out irrefutable correlations and typical errors of reasoning that often arise because concepts around money (gross and net financial assets, consumption and savings, etc.) are not clear.) be used imprecisely. These errors in thinking often stand in the way of a basic understanding of the monetary system.

In the fourth module of this blog, we will use macroeconomic accounting to explain why monetary wealth creation in one sector of an economy is only possible if all other sectors accumulate exactly the same amount of debt. Out of this irrefutable context we will create the so called "Financing Balances." which very clearly illustrate the macroeconomic interrelationships of a monetary economy.

In the final three sections (Monetary Policy I-III), there will then be a short introduction to the functioning of a central bank. This is only intended as an introduction to the subject and certainly not a comprehensive treatise of all monetary policy instruments and their possibilities as well as limitations. It is only intended to outline the most important functions and concepts related to modern monetary policy in order to clarify the major errors of thought and myths in this area.

At Links are finally links to interesannten and resuming Blogs to the topic money to find.

An introduction to how money works begins i.d.R. with the Means of exchange function. In a pure barter economy, goods would be exchanged for goods. For example, as a lecturer in economics, I can offer my baker a lecture on how the monetary system works in return for rolls for the rest of the month. If the baker agrees, the exchange can take place. Money is obviously not needed for this.

Money is only needed when an exchange takes place not can be concluded, because the parties involved cannot agree on an exchange of goods. This will obviously be the rule rather than the exception. For a pure exchange one would need namely a Koinzidenz der Bedurfnisse ("Coincidence of Wants"): if 2 people barter with each other, one would have to ask for a good that the other has in abundance, while the latter in turn desires something that is abundantly available to the first person. This coincidence should also spatially as well as temporally apply. If one person produces goods that are only made in the summer and another produces goods that are only made in the winter, then the difference in time alone can cause both people to be unable to exchange goods. Merchants have therefore always granted each other a deferral of payment. If this deferral is noted in the form of a promissory bill, under certain circumstances (which we discuss below) this promissory bill may become a generally accepted form of payment. Money is thus a IOU. In the past, such IOUs were brought to the market to be offset against each other.

Vermutlich wird der Backer im vorangegangenen Beispiel gar kein Interesse daran haben, einen Vortrag von mir zu horen. I think he would be more willing to deliver me buns if it would only mean he wouldn’t have to listen to me anymore. Therefore, I pay his rolls in monetary units with which the baker can buy goods from a third person, and so on. In diesem Beispiel ist Geld also ein allgemein akzeptierter Schuldschein, den ich dem Backer uberreiche und den dieser an Dritte weitergeben kann. Ultimately, you can use everything as money, as long as it is a general means of payment Accepts Will. Under these circumstances, the baker can use my promissory bill to liquidate other debt relationships, i.e. to settle his accounts with third parties. We will get to know the conditions that must be met for this function to work.

It is undeniable that a temporal and spatial coincidence i.d.R. is not the case and a market economy would not work without money. Therefore, it is reasonable to assume that a pure barter economy never existed. Let’s assume that there is no money yet, but I still want to buy from the baker. If the baker knows me and trusts me, he would probably grant me a deferral of payment – comparable to the merchants mentioned above. I would be able to credit the rolls. So the baker notes in monetary units that I owe him something, which I deliver at a later date. So the baker gives me one at this moment Credit. 1 Merchants have exchanged goods in this way long before the introduction of today’s paper and book money.

For example, so-called notch woods already functioned in the 11. In the nineteenth century as an early form of accounting for debt relationships. Notch timbers were elongated pieces of board on which symbols or notches were carved across the piece. The piece was then cut lengthwise and each party received one half so that no one could falsify the carved value. The debtor received i.d.R. the longer piece, the so-called "foil", while the creditor received the shorter end, the "stick". The saying "to have something on one’s mind" dates from that time, as does the term "stock exchange". The English government used money in the 18. Jahrhundert sogenannte „tally sticks“, um sich Gold und Silber von ihren Burgern zu leihen. Since people could pay their taxes with these notchwoods, tallies were henceforth accepted as a general means of payment and represented a form of money.

So it can be assumed that markets and early forms of (book) money emerged at the same time, because a market without money is not imaginable. So a pure barter economy has probably never existed. It is also reasonable to assume that simple clearing systems existed before precious metals, such as gold and silver, were used as a means of payment. The following picture shows how the Kerbolzer looked at that time.

Figure 1: Notched Sticks (Tally Sticks)

Source: Swiss alpine woods: double boiler of the alp Blumatt (Turtmann VS), 1893; Collection of the Alpine Museum of Switzerland; Photo by Sandstein.

This historical example alone already vividly illustrates that money can take many forms. An unambiguous Definition of money is becoming even more difficult today because there is an abundance of assets that are quoted in monetary units and can be "monetized" in the short term by selling them. These include z.B. so-called near-money claims on a commercial bank, which are not immediately available but can be exchanged for deposits in a relatively short time (z.B. Time deposits, deposits at notice, time deposits, or savings at legal notice). Depending on the economic problem one wishes to analyze, it may be appropriate to refer to such claims or even securities as money or quasi-money.

The German central bank, which calls itself the Bundesbank, also uses 3 different definitions of money (M1 – M3), which differ in their "Liquidity proximity" The difference between the two is how quickly they can be disposed of. In addition, there is the monetary base M0, the so-called central bank money (also referred to as reserves). This is money that can only be issued by the central bank and is primarily used to settle payment transactions in the system of commercial banks (the so-called interbank market). The Bundesbank, points out on its homepage the difficulties of defining the money supply: 2

Since the transitions between the different types of deposits and short-term financial instruments are fluid, the money supply cannot be clearly defined. Ultimately, it depends, for example, on the question of an investigation which deposit types are included in money and which are not or are not included in money. which monetary aggregate is used in the study. Against this background, other countries have defined their money supply according to different criteria, for example Switzerland and the U.S.A.

Table 1 summarizes the different monetary aggregates as defined by the Bundesbank. Each central bank defines its monetary aggregates somewhat differently, but in most cases very similarly. The basic principle is that the higher the number of the aggregate, the broader the money supply, i.e. the longer-term money investments are taken into account. Another monetary aggregate, which unfortunately is rarely used, is the so-called Divisia index by William Barnett (see z.B. Barnett and Spindt (1979)). This is based on a sum of different forms of money weighted by usability and is so far published regularly only by the Bank of England.

Table 1: Monetary aggregates of the Bundesbank

Modern monetary systems have a two-tier structure. They consist of a reserve and a giro money circuit. From the point of view of a bank’s customer, fiat money is what is known as the Money denotes. No one would question that the balance in a bank account represents money because we use it in daily payments and can exchange it for cash on a one-to-one basis at any time. For the banker, on the other hand, deposits represent liabilities. Customers can request a withdrawal at any time and lend the bank their money as long as it remains in the current account.

On the other hand, a bank needs reserves, i.e. central bank money, to settle payments with other banks. From their point of view, reserves are the “real” money they use to make payments. In the definition of the larger monetary aggregates from table 1, longer-term time deposits, short-term bank debt securities, money market funds and repurchase agreements are also counted as money. These are z.T. also credit agreements between private companies. If one adds other private non-bank financing, such as investment funds or the ability to raise money through corporate bonds, etc., to the equation, the bank does not need deposits at the time of lending., can be Pyramid of money construct the money pyramid as shown in figure 2.

Figure 2: Pyramid of money (pyramid of liabilities)

Source: Own creation.

For each form of money, it is true that it represents a promise to pay the form of money of the next higher level in each case. Loans are promises to pay deposits at a later date. deposits are promises to pay cash, i.e. central bank money, at a later date. And central bank money used to be the promise to pay gold at a later time. Gold was the only internationally recognized currency in which to settle trade and was still above central bank money at the top of the money pyramid in the hierarchy of money. 3 In English, one often speaks of “moneyness” when describing the hierarchy of money. Central bank reserves, according to the pyramid, have the highest degree of moneyness (domestically).

Another feature of the money hierarchy is that the lower levels multiply each higher type of money. Trade credit, a deferred payment of, say, 90 days, is a promise to pay deposits in 90 days. However, it does not require deposits at the time of lending. The borrower may already have some of the deposits and expects sufficient additional income by the time of payment to. Or it may assume that it can “roll over” the loan, i.e., replace it with a new loan. Either way, the quantity of credit has increased without requiring deposits. This becomes even clearer if we take the example of a credit card payment. At the moment of payment, two credit contracts are created for a transaction. First, the credit card company lends its customer the amount needed to complete the payment transaction until the end of the month. On the other hand, the seller lends the same amount to the credit card company, since the transfer i.d.R. only occurs after a few days.

Moreover, the pyramid of money is to be understood dynamically. The extension of credit i.d.R. expires in boom phases and shrinks again in crises (“bust”). 4 The central bank tries to influence this dynamic process with its interest rate policy. Raising interest rates in boom periods makes new borrowing less attractive and is thus intended to protect against a credit bubble and rising prices, while lowering rates in times of crisis is intended not only to stimulate investment but also to make it easier to refinance current loans. If a company cannot meet its payment obligations at the agreed time because it is making less revenue than expected during the recession, it can push its short-term liquidity problems into the future by taking out a favorable bank loan in the hope that things will improve by then. By controlling interest rates, the central bank thus attempts to keep both the Flexibility of this system (banks can create loans as needed), as well as disciplining to act on banks (by paying them, if necessary. increase interest rates on banks’ loans to the central bank).

The central bank is something like the bank of commercial banks and legally has a monopoly on issuing a currency. Since cash in the form of coins and bills is now a very small part of the total money supply, the monopoly on the creation of the Reserves the essential feature of a central bank. Reserves are the official means of payment in the monetary cycle between the central bank and the commercial banking sector. The private sector can never pay with reserves, as they are only exchanged in the accounting system between the central bank and the commercial banks. Reserves, however, can be exchanged by banks for cash at the central bank at any time. Accordingly, cash represents the only form of central bank money that can also be used in the private sector. The two monetary circuits are shown in Figure 3. 5

Figure 3: Money cycles

Source: Own creation.

Since reserves and cash are created only by the central bank (and not by the private sector), they are also referred to as “outside money” or “external money”. However, there is a second money cycle between (non-financial) businesses, households and banks, in which bank-created scriptural money (also referred to as book money) acts as a means of payment. Since this money is created by private banks, it is also referred to as “Inside Money” or “domestic money.”. Banks obviously have a special function in this system, as they are the interface between the two money circuits and are the only actor to carry both reserves and book money on their balance sheets (on different sides). As we will see in the last sections, banks hold reserves as balances with the central bank and create deposits as liabilities to their customers.

But isn’t it quite risky to open up the possibility for private banks to create money on their own? Shouldn’t we rather ensure again that money is backed by gold, so that banks keep their customers’ balances in stock in the form of gold? As we have seen from the notchwood example, it does not even take a private bank to create a loan. During periods of the so-called gold standard, in which the central bank insured to exchange money for gold at a predetermined ratio, liquidity shortages regularly occurred because the increase in trading activity was not accompanied by an increase in the money supply. To ensure the latter, additional gold would have been needed. Often the gold standard was then abandoned or merchants wrote promissory bills to each other, z.B. in the form of bills of exchange to escape the shortage of money. Without money creation in the private banking sector, such periods could recur. This would be a very harmful development for trade. On the other hand, it should be clear that completely uncontrolled private money creation can cause major problems (as the global financial crisis has impressively shown). We will return to the question of the importance of the commercial banking sector, as well as the role of the central bank in the so-called interbank market, in the last 3 modules of this blog.

But what actually makes money now? Most non-economists do not have to worry about such questions. For them, money is the sum of coins, bills and what is in their bank accounts. Since demand deposits can be used for the vast majority of general payments, they are clearly part of the definition of money. Ultimately, from a bank customer’s perspective, deposits represent circulating claims The private sector can never pay with reserves, as they are only exchanged in the accounting system between the central bank and the commercial banks. This is a digital IOU of the banking system that can be used in the private sector to purchase goods and services. The reason for the acceptance of a money is explained in most textbooks of monetary theory on the following properties or. Functions relegated:

(i) It is generally accepted medium of exchange, since it could be used to exchange goods and services with all merchants.

(ii) It is Means of payment, since it can be used to settle accounts, i.e. to dissolve debt relationships.

(iii) It is Store of value, because one could keep it on hand to maintain one’s ability to pay.

(iv) It is the general unit of account, since all goods and services can be valued in monetary units and their prices can be compared with each other.

As can easily be seen, the individual functions of money influence each other. It would certainly not be accepted as a means of exchange and payment if it had no stability of value. If one could not estimate the purchasing power of a euro in the future, one would hardly accept it in exchange for goods. As a unit of account, money would not function if it did not have a medium of exchange function. If goods and services cannot be acquired with the help of money, it is obviously also impossible to value and compare them in monetary units.

The store of value function is affected by the rate of inflation, i.e., the rate of price increase, since higher prices mean that one can acquire fewer goods with the same amount of money. Therefore, a low inflation rate is an important goal of economic policy to ensure the acceptance of money as a store of value. In times of high inflation, there may be other objects that take over the means of payment function of money. Gold or other precious metals then often serve as a store of value, or tangible assets such as houses, the so-called concrete gold. However, even these assets do not have constant purchasing power because their value, that is, their price relative to other goods, is subject to fluctuations. During the build-up of the great real estate bubble in the run-up to the global financial crisis, real estate prices rose sharply, initially increasing the wealth of many households. However, the sudden collapse of real estate prices after the outbreak of the financial crisis “destroyed” these assets again. 6 This had serious consequences, as many homeowners had taken out mortgage loans in which the property was pledged as collateral.

For some years now, digital “currencies” such as Bitcoins have enjoyed ever-increasing popularity. Proponents of this asset like to claim that the political independence of digital currencies would be the great advantage of this new form of money. Since the money supply cannot be manipulated, these “currencies” are more stable in value. However, if one looks at the evolution of the prices of such digital constructs, this argument appears very quickly invalidated. The lack of political influence on digital currencies is the major Achilles’ heel of these assets, as it leaves their price completely at the mercy of fluctuations in demand for them. Since you can’t use Bitcoins in general payments, you have to convert your Bitcoins into demand deposits beforehand. The price of this exchange is subject to such enormous fluctuations that it is impossible to predict today what the value of the currency will be tomorrow. By comparison, both the level and volatility of consumer price inflation, which can be used to gauge the stability of the value of deposits, are decidedly low. Bitcoins are therefore useless as a general means of payment. And no one can assure that the valuation of Bitcoins will not collapse in exactly the same way as real estate did during the financial crisis. We will see that an institution such as the central bank is needed to ensure monetary stability. In particular, it is those “manipulations” of the money supply, always criticized by proponents of digital currencies, that ensure stability of value.

The just presented considerations make clear that the inflation rate has influence on the value of money. It therefore represents a Price of money dar. But there are other metrics that can be called the price of money. American economic historian Perry Mehrling introduces a total of 4 prices of money, referring to the relative value to cash: 7

(i) The price of deposits is i.d.R. pari, since deposits can be exchanged one-for-one for cash. Cash and deposits therefore have the same value. This may well be overridden in times of crisis. For example, if a severe financial crisis causes all customers to want to withdraw their deposits at the same time, the bank may refuse to issue cash after a certain point, or at least restrict it. In this case, one can no longer exchange one’s deposits for cash at all, or only to a limited extent.

(ii) Another price Interest rate, because it determines what price one has to pay for a loan. A borrower undertakes to pay the loan plus. to pay back the interest in the future.

(iii) The Exchange rate determines the price of foreign money, as it indicates how much foreign currency one can exchange for a given amount of domestic currency.

(iv) The final cost of money is the one already mentioned above Inflation rate, which determines the future purchasing power of money.

Many economists place particular emphasis on the institutional foundation of money. Accordingly, money has the properties listed above primarily because the government forces all citizens to accept the currency it has introduced as a means of payment. The government can do this by paying all payments such as income tax, VAT, fees and penalties, etc. accepted only in the currency it specifies. Georg Friedrich Knapp, with the publication of the “State Theory of Money” in 1905, founded the so-called Chartalism (Charter = deed, i.e., securitized money, see Knapp (2018)). 8

According to him, state sovereignty consists of three monopolies: The to set national currency as the unit of price and calculation, the Means of payment to be issued and the associated Money creation profits to realize. The latter is also called seignorage. Originally originated Seignorage by the fact that the cost of making the coin was less than the value of the gold coin. If it takes just one pound’s worth of gold to make a two-pound coin, you make a profit of one pound per coin. This profit was realized by the government using the money to meet its expenses, i.e., purchasing £2 worth of goods with it.

Since coins play virtually no role in today’s payments, seignorage is now usually equated with central bank or banking interest gains. However, the profits from lending are not really seignorage, but payment for the services of central and commercial banks (cfb. with the payment of a notary). From the income of the credit business, the employees and all other costs (rents, etc.) paid.

Money is only generally accepted because the government accepts it as a means of payment. Because every citizen has to pay taxes and fees in the currency determined by the government, everyone has an interest in using just this currency as a means of payment. The Modern Monetary Theory (MMT) has developed a theory based on this insight, which regards money as a tax credit (comparable to notched wood in England). The state and the central bank are therefore the creators of money and all others are merely the users. 9

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