Money Creation

Central Banks have the unique power to create money, but how is it done?  

Money creation involves the interplay of the Central Bank, commercial banks and the public.  However, before we do we should review a few things.

Money

This might seem like a silly question. I have banknotes in my wallet, credit and debit cards and bank accounts, so I can buy stuff. What more is there to it? However, the answer turns out to be that money is a psychological concept that is universally accepted without question (and it is best that it stay that way!) So, it is nothing at all, and yet without it our economies would crumble. If this sounds a little weird, let’s examine money a little more deeply.

The Monetary Policy Transmission Mechanism

A few years ago I was authorized to hire a Junior Economist out of University. I checked CVs and
interviewed a number of candidates. I remember in one interview I asked a fellow what Monetary
Policy meant to him. He thought a minute and said, “It has to do with money, right?” I wanted to
answer, “Oh, ya think?” But there is a subtlety to the actual answer.
So, suppose a Central Bank wishes to loosen monetary policy. What are the mechanisms at play
whereby the real variables of GDP, unemployment and inflation are affected? Below is the standard
Central Bank explanation, and a disconnect as well as a serious weakness.

Real World Inflation

Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua.