One of the most common questions people ask is: How is FIAT money created? In this article we will talk about one of these ways: Open market operations. We will begin by knowing that open market operations are those transactions of “buying and selling” of financial assets, which is only carried out by the central bank of a country. They are in essence the most important financial instrument in monetary policy. The central bank has different mechanisms to “increase” the amount of money circulating, taking into account inflation and open market operations. Of these mechanisms, this article will analyze open market operations.
Decision to increase or decrease the amount of money in the economy
The central bank authority must make the decision as to whether it is desired to “increase or decrease” the amount of money in the economy, and almost usually, it is decided to “increase” the presence of money, as this It allows the government on duty to remain “on top” to generate welfare in the population (even at the cost of generating possible economic crises).
Central Bank auction
After making the decision to “increase” the presence of money in the economy, the central bank decides to offer an amount of money through an auction. The head of the central bank summons said auction to commercial banks (which have accounts in said bank), and reports the amount of money that will be auctioned (and the conditions of the auction).
Commercial bank money and central bank money
It is important to note that all banks have money from the central bank (they have an account at the central bank), which can be “lent” to other people, businesses or companies by converting it into “commercial money”, although the backup rate varies In each country, we can say that on average, with a single dollar of «central bank money», a commercial bank can lend up to 10 dollars to other people, businesses or companies, this additional money is called «commercial money».
The auction money has to be “returned”
As we saw earlier, having money from the central bank allows banks to lend more money (and create more commercial money) so they decide to participate in the auction. Suppose that in this auction the central bank offers 1 000 000 dollars in central bank money, however, as this money must be returned, what is actually offered is… lend 1 000 000 dollars and within a year it must be return an interest of $ 10,000 (in total $ 1,010,000 to give an example), this “extra” amount is the interest rate which in this case is 1%, in addition, so that banks are encouraged to return the money, the central bank will ask commercial banks to generate public debt securities (which the central bank will keep and can use to claim that amount).
What is the problem with these auctions?
The problem is that these types of actions create distortions in the economy exponentially (since the more money the central bank believes, the more commercial money it will originate), although doing these types of actions “occasionally” may not being so harmful, the problem is that these types of actions are usually done continuously, this problem has a “turbo” button (which can be used by the central bank) which consists in “changing” the conditions of the auction, this change is that all requests from commercial banks “are automatically accepted” and without establishing a return date (the only requirement is that they contribute state debt in return), this results in the “public debt” securities being highly demanded by commercial banks and that “private debt” goes to the background, all these actions expand money in the economy creating inflation and generating various economic problems.
In the following YouTube Economic Pills video this process is explained in a simple (and very enjoyable) way, you can see it in the following link.
What do you think about this topic? Did you know how Fiat money is created through open market operations?
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