How_Money_Works_-_The_Facts_Visually_Explained

(Greg DeLong) #1

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GOVERNMENT FINANCE AND PUBLIC MONEY

Managing state finance

Open market operations: selling bonds
The central bank sells bonds back to the market in exchange for money, causing
investors to make withdrawals to buy the bonds, lowering the amount of money
in the banking system. Commercial banks respond by raising interest rates.

Decreasing money in circulation


1668


the year that the


oldest central bank


in the world, the


Swedish Riksbank,


was established


Higher interest rates make central
bank loans more expensive

The central bank sells
bonds to investors





€ €


€ €

€ €

Investors withdraw money
from banks to buy bonds

Less money
circulates

Commercial banks’
reserves decrease

Higher interest
rates paid

Commercial banks’
reserves decrease

Higher interest rates
make loans more expensive

Higher interest rates
make loans more expensive

€€€

€€€

Less money
circulates

Credit guidance
The central bank’s control of
commercial banks’ licences means
that it is able to influence how
commercial banks lend. It can, for
example, give commercial banks
incentives to encourage them
to offer very low interest rates to
important sectors of the economy.

Open market operations
The central bank buys and sells
bonds in the open market to affect
the short-term rates of interest.
Credit access
The central bank can restrict access
to credit for commercial banks, for
example by raising the amount of
deposits they must hold as reserves.

CENTRAL BANK CONTROLS


Raising the reserve (base) rate of interest
The central bank can curtail commercial banks’ lending to the public by raising its
reserve rate of interest. This makes it more expensive for commercial banks to borrow
from central bank reserves. Commercial banks then raise interest rates for borrowers.

Central bank Investors in Commercial banks General public Money supply
bonds

Central bank Commercial banks General public Money supply

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