What is money?
Money is what the citizens in society agree it should be. For this agreement to work, three important functions need to be fulfilled:
- All prices of goods and services shall be expressed in the unit we define as money so that we can easily compare the prices of different things. In Sweden, this unit is the "krona".
- The value of money rests on the confidence of the general public. What we have chosen as money shall function as a store of value, that is, the value of money shall remain stable over time. This enables us to consume immediately or to save money for consumption at a later date.
- Money needs to function as a means of payment, which means that everyone we want to do business with must accept it as payment. This may mean that the definition of money applies to a certain country or area.
From shells to digital money
When we speak of money today, many probably think of a banknote in some currency or another. But in today's digital society, cash forms a very small part of the total amount of money, only about 2 per cent. Virtually all the rest is electronic.
Through history, we have used different objects as money to facilitate trade and consumption. Everything from shells, gold objects and metal coins to bits of paper or notes when printing technology came along. More recently, our funds in bank accounts have, to an increasing extent, been used for payments, that is, as money. To begin with, we used cheques, bills of exchange or paper giros, but technological development has resulted in us nowadays using digital money via various online services and mobile apps.
How is money created?
There is a difference between central bank money and private bank money. Central bank money is money created by the Riksbank and hence constitutes a claim on the Riksbank, i.e. the Swedish state. Commercial bank money is created by banks and hence constitutes a claim on the issuing bank.
Central bank money
Central bank money is Swedish kronor issued by the Riksbank. Central bank money can be physical money, i.e. notes and coins, or the money in banks' accounts in the RIX payment system, which is owned and operated by the Riksbank. The Riksbank creates central bank money by issuing notes and coins and lending electronic money in Swedish krona to commercial banks via RIX.
The state, via the central bank, has had a monopoly on issuing notes and coins since 1904. The advantage of state issuance is that the state's notes and coins are usually considered to be completely safe. Similarly, the electronic money that banks have in RIX accounts is also considered to be completely safe as it is guaranteed by the state.
Private bank money
As regards electronic money, it is not only the Riksbank that creates new money in Sweden. In the current situation, banks can also create new money when they issue new loans. For example, if a bank grants a customer a new home loan, the customer will have a debt on their account at the bank. At the same time, the money borrowed by the customer is transferred to the seller of the home, who deposits the money in their own bank account. This is how new loans create new money. In the same way, the amount of bank money decreases when the customer pays back the loan to the bank.
Deposits that private individuals and companies have at banks are normally considered less safe than central bank money. If a bank were to go bankrupt, it is not certain that depositors would recuperate all their money. However, deposits in bank accounts are protected by a state guarantee, known as the deposit guarantee, up to a certain amount. With the help of regulations and the deposit guarantee, the state has attempted to ensure that it is as safe for the general public to use private money as central bank money. The state has done this because society gains from the state creating confidence in the payment system.
How much money is there in society?
The amount of money increases over time, partly because things become more expensive and partly because the economy grows. There are more of us buying more things for every passing year, creating a need for more and more money. The Riksbank's task is to ensure that there is always enough central bank money to meet demand. This is a question of both the amount of notes and coins required in society and how much money banks need to lend from the Riksbank. The Riksbank conducts what are known as "market operations", which can increase or reduce the amount of central bank money.
But there is no particular target for how much money should be in society. Instead, we have an inflation target of 2 per cent to ensure money retains a stable value. To achieve this target, the Riksbank raises or lowers the policy rate (the repo rate). This rate is the price of money, so by raising or lowering it, we affect the demand for money in society.