People think that Central Banks ‘create money’ or ‘control the money supply’ but this is not true. Most money is deposit money, or commercial bank money, created by the loan making activities of private banks, and over the creation of/destruction of this kind of money they have no overt control. Rather, they seek to influence the quantity of money by acting on what they can control, namely, central bank money. Central bank money is a special kind of money that only banks use, and is the mechanism by which banks settle payments. Whilst all commercial bank money is a claim on central bank money, like paper money used to be a claim on gold, the amount of commercial bank money vastly exceeds the amount of central bank money just like paper claims on gold used to exceed the supply of physical gold.
So central banks actions for me and you are pretty 2nd degree. None of us use central bank money, we use commercial bank money. An increase in commercial bank money supply (by loan making) can have effects in the real economy, but supplies of cash to banks by a central bank only increases the money supply by effectively giving banks the confidence to lend more loans because they have more central bank reserves to back up any payments they will need to make. However, the link is not simple. If I am a bank treasurer sitting on a book of bad loans, I know that I will need a lot of central bank money in future to settle claims made on me by other banks. Any excess liquidity provided to me by the ECB will be used to shore up my balance sheet, not expand it. The duality of the two types of money makes central bank action ineffective in the kind of recession we have now, ie, a balance sheet recession where banks are not refusing to make loans because they don’t have cash, they have loads, but because they have a deadly combination of no confidence in the rest of the economy and uncertainty over future payments they will have to make. Thus, they hoard central bank money, whilst shrinking their balance sheets, the availability of credit and the money supply.
Apologies for any Econ/Finance professionals reading for whom this should all be well understood, but I think it’s worth ramming home just how little we should care what the ECB does today. Sure, their activities can and will excite financial markets, but that’s because financial firms and financial products are effected by Central Bank action in a way that the wider economy simply isn’t. The market cares a great deal whether the ECB lowers the interest rates paid on excess reserves, encouraging banks to lend more to each other. The world does not. The fundamental link that allows central banks to control prices and economic activity by changing the supply of central bank money is broken for the same reason that the economy is broken: Private banks are in charge of the supply of money. The only way to make policy effective and fix our macroeconomic woes is to solve this problem.