Who makes money?

The central bank doesn't print money.  So what?

Conservative critics of the central bank blame it for increasing prices in general, by “printing money.” The usual liberal response – among non-economists – is that the bank doesn’t print dollars and so isn’t responsible for a surfeit of them.

Of course, the bank doesn’t literally have a printing press. Creating coins and paper money is the job of the government mint. Nevertheless, the central bank determines the money supply, especially in the long run, although its influence is indirect.

The simplest way for the bank to affect money is to cut a deal with the public Treasury, the agency that raises the amount of money that the government has decided to spend. If tax revenues don’t suffice, then the Treasury must borrow. It issues I.O.U.'s -- bills, notes and bonds -- through which it usually pays interest periodically in exchange for loans upfront. It would like to borrow as cheaply as possible, by holding down the interest rate that it must pay. A congenial central bank can make the Treasury’s dream come true by buying the government’s bonds. This increases the overall demand for the bonds -- and thus increases their value for their seller, by reducing the interest that it must pay on them.

Where does the central bank get the dollars (or tenge, or whatever) for buying the bonds? Out of its “reserves,” which essentially are safes holding dollars. These reserves are not truly money, since their locked-up dollars are not available for spending. But once the central bank takes the dollars out of reserves and exchanges them for public bonds, the government can spend them on anything.  So they now become money. The central bank has just increased the supply of dollars, even though it didn’t print them. Similarly, if the bank wants to reduce the money supply, then it can sell bonds in exchange for dollars and stash these back in reserves.

The mild, mild West

Most central banks in the West resort to purchases and sales of bonds – “open market operations” – in order to manipulate the money supply. These days, they rarely cut explicit deals with the Treasury. The central bank in the United States, the Federal Reserve, declared its independence of the Treasury Department more than 60 years ago; the charters of some other central banks prevent them from lending directly to their governments. Nevertheless, in a recession, the central bank may buy bonds – and even commercial paper, a form of short-term loans to businesses – in order to give people more spending money, revving up the economy.

The central bank can also increase the money supply by encouraging commercial banks to loan out their reserves. Again, the lent dollars now qualify as money, either as cash or checking accounts. To coax these private banks into lending, the central bank may lower the share of their reserves that it forbids them to lend – the “required reserve ratio.” Or it may lend them its own reserves at a reduced rate of interest, known as the “discount rate.”

The National Bank of Kazakhstan has usually taken this route when it wanted to encourage spending. In recent years, it has increasingly resorted to open market operations. But it faces the same constraint as do central banks in other transition economies – the financial markets in Kazakhstan are still too thin to absorb a lot of bond trades. The consequences of a major bond purchase are not easy to predict.  So the National Bank tended to stick to the tool that it knew best -- the rediscount rate, which has risen slightly to 7.5% in order to contain inflation. 

The Bank's 2011 guidelines identify notes and commercial bank deposits with itself as its "main tools" for stabilizing interest rates.  It has increased slightly the required reserve ratios for commercial banks, which are higher for foreign deposits than domestic ones; but the ratios remain close to zero. 

Even if a central bank did run the mint, it would not control the money supply perfectly, especially in the short run.  The supply depends on the alacrity of private banks in lending and on the share of money that individuals hold as cash rather than as checking accounts.  If banks lend eagerly, and if households prefer bank accounts to fat wallets, then the money supply may increase sharply.  That's because the bank may lend much of Smith's checking deposit to Jones, creating (say) $1.80 for every $1 in the account. 

In Kazakhstan, commercial banks were scorched by the 2008 crisis and remain reluctant to lend today.  Also, Kazakhstanis prefer to pay with cash than with checks.  These facts restrict some factors affecting the tenge supply that are beyond the National Bank's control.  Thus the Bank can manipulate the money supply more precisely than is usual for central banks.  This may help account for its relatively good record of inflation (relative, anyway, to some other countries in the Commonwealth of Independent States, like Georgia): about 9% per year, just outside the Bank's target range of 6-8%.  -- Leon Taylor, tayloralmaty@gmail.com


References

National Bank of Kazakhstan.  Monetary policy guidelines for 2011.  Online.