Monday, December 16, 2019

Government and Money

A country's government and central bank play a key role in the circulation of money in the economy. They monitor money supply, send funding to key sectors of society, and ensure that cash flows back to them for state spending.

How it works

A healthy economy requires a good money supply. Although it is difficult to control the supply of money directly, government monetary policy can help to influence it. The most important institution in monetary policy is the central bank, which is critical in determining interest rates and can be used to inject more money into the economy via open market operations or through quantitative easing. Governments may also control the flow of money via taxes and other capital controls, and by restricting borrowing and lending. However, these mechanisms are imperfect in the modern monetary system, since commercial banks are largely free to decide the terms of their lending. Attempts to directly control money supply tend to fail.

Money supply and a healthy economy

As a healthy body depends on a good blood supply to receive nutrients, so a healthy economy requires a good money supply to keep the cycle of spending going: as one person spends, another earns, then spends, and so on. If this cycle slows, the economy may begin to decline. The government, via the central bank-which is like the beating heart of the economy-helps to keep money flowing. Meanwhile, the government also ensures that funding reaches key areas of society, while collecting revenues for state spending. Economic policies around interest rates, reserve ratios, open market operations, and quantitative easing are all focused on maintaining money supply. A body may have optimal blood supply, but it is down to the cells to effectively utilize the nutrients. In the same way, while a government can improve money supply, economic growth then depends on how effectively individuals and businesses are able to convert this money into useful goods and services to raise living standards.

Need to Know

> Money supply: The total amount of money circulating in a country, from currency to less liquid forms.

> Central bank: An institution that provides financial services to the government and commercial banks, implements monetary policies, sets interest rates, and controls money supply.

> Currency in circulation: Money that is physically used to conduct transactions between customers and businesses.

The case for independent central bank

Many central banks were made independent of the government in the early 2000s, although they are still required to be both transparent and accountable. The 2008 crash led some to question whether independent banks are desirable.

Pros Cons
> Monetary policy can be more
impartial as banks have no interest in maintaining electoral popularity.

> As they are unaffected by the electoral cycle they can plan and implement long-term policies.

> Independent banks have tended to maintain lower rates of inflation.

> Unelected bank cannot be voted out, arguably making  them less accountable.

> Central bank controls may not be enough to avert financial crises without government aid.

> Governments may blame banks for recessions, so eroding trust.


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