What is money?
Money is what the citizens in society agree it should be. Throughout history, we have used everything from shells to large stones to precious metals as money to simplify trade and consumption.
For this agreement on money 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 ‘Swedish 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 makes it possible for us to consume directly or save money and consume 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 1.5 per cent. The vast majority of the money in circulation is digital, which is to say that it exists in bank accounts and can be used for payments.
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 applications.
How is money created?
Depending on how the money is created or who is issuing it, a distinction can be made between central bank money and private bank money. Central bank money is money issued by the Riksbank and thus the Swedish state. Private 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, which is to say banknotes 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 banknotes and coins and lending digital money in Swedish krona to commercial banks via RIX.
The state, via the central bank, has a monopoly on issuing banknotes and coins. The advantage of state issuance is that the state’s banknotes and coins are usually considered completely safe. Similarly, the digital money that banks have in RIX accounts is also considered completely safe as it is guaranteed by the state.
Private bank money
Private bank money is the money held in accounts with private banks. This money is a claim on the bank. The banks can supply new private bank 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 to the bank that is equivalent to this loan. At the same time, the bank deposits funds equivalent to the borrowed amount into your account. It is this newly created money that you then transfer to the seller of the home. This is how new loans create new money in the system. In the same way, the amount of bank money decreases when you pay 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, for example 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 equity (read more about capital requirements imposed on banks on the Finansinspektionen website, in Swedish). In addition, the banks cannot lend more than the public demands. The central banks can influence actual demand for loans by raising or lowering the policy rate, which in turn affects the banks' lending rates.
Central bank money is the safest type of money. This is because the Riksbank cannot go bankrupt. However, with the help of regulations and what is known as the deposit guarantee, the state has attempted to ensure that it is almost as safe for the general public to use private money as central bank money. The deposit guarantee means that deposits in private bank accounts are protected by the state deposit guarantee, up to a certain amount. The state has done this because there is socioeconomic benefit to be gained from the state creating confidence in the payment system.
Electronic money (e-money)
In addition to central bank money and private bank money, there is electronic money or e-money, which is a form of private money. E-money is an electronically stored monetary value that is used to make payments. Like private bank money, electronic money represents a claim on the issuer. To be e-money, it must also be accepted as a means of payment by more than just the publisher. For example, e-money can be used to make electronic payments that do not go through a bank.
Banks and credit market companies may issue e-money within the framework of their existing authorisation. E-money can also be issued by electronic money institutions and by what are known as registered issuers. In Sweden, e-money is a relatively unusual form of money but in other countries, such as the UK, it is more common. The issue of e-money in Sweden is regulated by the Electronic Money Act (2011:755) and it is Finansinspektionen that exercises supervision.