Inflation causes the value represented by paper money to decrease, leading to rising prices. But what is the process of this real-world movement? In other words, what happens from the moment a country overspends on money to the rise in prices, and what processes are involved in between?
First, here is a typical explanation from bourgeois macroeconomics regarding the “general monetary policy tools” for financial policy. We will then discuss inflation.
The Three Main Monetary Policy Tools for Central Bank Regulation of the Macroeconomy
The three commonly used monetary policy tools by central banks include:
- Discount Rate (Rediscount Rate)
- Open Market Operations
- Reserve Requirement Ratio
Together, they help the central bank achieve macroeconomic regulation goals such as stabilizing prices, promoting economic growth, and achieving full employment.
1. Discount Rate (Rediscount Rate)
- The discount rate is the interest rate charged by the central bank when rediscounting eligible promissory notes held by commercial banks that have not yet matured.
- When commercial banks face liquidity shortages, they can apply to the central bank for rediscounting these notes to obtain funds.
- The interest rate charged by the central bank is the discount rate.
✦ Policy Effects:
- Increase in the discount rate → Higher financing costs for commercial banks → Suppresses credit expansion
- Decrease in the discount rate → Lower financing costs for commercial banks → Stimulates credit growth
2. Open Market Operations
- Open market operations involve the central bank buying or selling government bonds or other securities.
✦ Methods and Effects:
- Central bank buys bonds → Injects funds into the market → Increases the money supply
- Central bank sells bonds → Withdraws funds from the market → Reduces the money supply
Open market operations can flexibly adjust market interest rates and the money supply, making it the most frequently used monetary policy tool by central banks.
3. Reserve Requirement Ratio
- The reserve requirement ratio is the proportion of deposits that commercial banks must hold in reserve at the central bank relative to their total deposits.
✦ Adjustment Effects:
- Lowering the reserve requirement ratio → Releases more funds to commercial banks → Increases credit supply
- Raising the reserve requirement ratio → Reduces the amount of funds available for lending → Decreases credit supply
By adjusting the reserve ratio, the central bank can influence the monetary multiplier and the overall money supply.
Rediscount rate is the interest rate charged by the central bank when commercial banks discount commercial promissory notes (drafts, bills of exchange). The bourgeoisie can control the financing costs of commercial banks by adjusting the rediscount rate because commercial banks obtain short-term loans by discounting the notes held by enterprises. Commercial banks then take these notes to the central bank for discounting, using the cash received to lend out again or invest. If the rediscount rate decreases, it will inevitably increase the scale of discounting by commercial banks to the central bank, and also increase the scale of commercial note discounting absorption, speeding up the circulation of commercial notes. The cash obtained from discounting commercial notes will increase, leading to more money supply in society.
Open market operations generally involve the central bank buying government bonds from the government and providing cash, or selling government bonds to the government and recovering cash. This affects the amount of money circulating in society through the government.
Reserve requirement ratio is well known.
Regardless of the method, the mechanism of their action is the same. After the money supply increases, banks increase their credit scale or the government increases investment, money flows into real estate developers, large enterprises, or government contractors. These bourgeoisie entities use the money to expand production, increase the expenditure on means of production, or invest more in real estate or stock markets. This leads to rising prices of means of production, real estate, and stock prices. These price increases then translate into higher production costs for all bourgeoisie, which in turn cause the prices of goods to rise. Consequently, this triggers inflation across society. However, at the same time, workers’ wages do not increase, resulting in a decline in real wages. This is the general process of inflation in contemporary capitalist society.
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