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. Banks also supply new money to the system when they issue new loans. For example, if a bank grants you a new home loan, you will have a debt on your account at the bank. At the same time, the money you have borrowed 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 system. In the same way, the amount of bank money decreases when the customer pays back the loan to the bank.
However, banks cannot create an infinite supply of money (credit) as they cannot lend an unlimited amount of money. Lending is restricted by laws and regulations that govern how banks are allowed to operate. For example, banks need to have a certain amount of money in liquid funds to avoid a liquidity crisis and run short of cash if people want to withdraw money from their bank accounts. They are also subject to certain capital adequacy requirements, which means that for every krona they lend they need to retain a certain amount of capital (read more about capital requirements imposed on banks on the Finansinspektionen website, in Swedish).
Banks fund their lending both using their own capital and by borrowing from other parties. A large part of a bank’s loans is money deposited by customers in accounts at the bank. But banks also borrow a lot of money on the capital markets, for example by issuing bonds that are bought by investors around the world.
Finansinspektionen is the authority that monitors banks and other companies on the financial market to ensure that they adhere to the regulations governing the bank and credit market.
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.