ABSTRACT
In most of today’s monetary systems, the monopoly for production of cash lies with the state. As we’ve seen above, in a pure credit economy there’s no need for cash. Even though today we handle the bulk of our transactions through transfers of bank deposits, we still expect banks to deliver cash to the full extent of our deposits, whenever we go and demand cash in exchange for a decrement of our deposit account. Since we do not get our cash directly from the central bank, the mechanism must be more complicated than is normally assumed. There are three essential mechanisms by which commercial banks can increase the amount of cash or deposits at the central bank. First, banks can increase their holdings of cash by borrowing directly from the central bank. Second, the central bank can influence the amount of central bank deposits held by banks through ‘open market operations’, i.e. by buying (or selling) illiquid assets and hence providing banks with more (or fewer) central bank deposits. The central bank usually does this in order to change the short-term interest rate. Or third, central bank deposits increase following an increase in fiscal spending. In this section we focus on the first two possibilities; the third is covered in the following section. Let’s have a more detailed look at the creation of bank deposits first.
