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Currency is just paper today. It is of psychological nature and relies only on confidence.

Monetary policy is therefore easy and very complex at the same time.

The basic equation of monetary policy in a close economy is:

(Flow of currency) = (Flow of goods and services)



(Flow of currency) = (monetary mass) * (velocity of circulation of money)

(Flow of goods and services) = (Prices index) * (Production SOLD)

This equation may be of interest in an open economy if fiscal measures are taken, such as variable VAT, to make domestic production more competitive. Without such fiscal measures, all your monetary or budgetary strategies will benefit a more competitive foreign country, just as the United States budgetary policy now benefits more to Chinese than to US firms and workers.

A. If the flow of currency is increasing (too much money or too much velocity of circulation), and if at the same time there is the same flow of goods and services, then the average price of goods and services will rise: it's inflation.

To curb inflation, the possibilities are:

monetary authority

2. to decrease the velocity of circulation of money: by immobilizing large amounts of money: it is Mr. Greenspan's  real strategy to curb inflation by immobilizing hundreds of billions dollars in Asiatic central banks:

Bank of Japan reserves in Billions of dollars

(Note that Asiatic countries benefit this strategy because inflation in the US would make dollar weaker and US firms more competitive: As a consequence, Asiatic exportations in the US would decrease, making their economy grow slowly... That's the reason why Asiatic countries support this policy by buying huge amounts of T-bonds with their dollars, until their economy and production process become stronger than the American ones).

3. to increase the Production sold: 
a) if there is too few Goods and Services available, one should increasing production, importations, and research to create new innovative products; 
b) if there is enough Goods and Services available one should give or lend money to the people who lack (welfare state) to stimulate the economy.

B. If the flow of currency is decreasing (lack of money or lack of velocity of circulation), and if at the same time there is the same flow of goods and services, then the average price of goods and services will decrease: it's deflation.

To curb deflation, the possibilities are:

1. to increase the monetary mass: by monetary creation (simple creation, special bounds creation, creation guaranteed by gold, foreign currencies reserves or domestic assets, ...) or by debt and ordinary bounds emission.

2. to increase the velocity of circulation of money:  by exceptional fiscal measures, each during 2 or 3 months, to induce people into spending their money

3. to decrease the production sold: in taxing unnecessary goods or services, taxing unnecessary importations, regulating lending, ...

The more comfortable situation is at the same time a growth in the flow of currency and of the production sold. Then prices remain stable:

These are basic monetary rules.

Let's talk about key public monetary choices:

Usually, sold production increases since the society develops. Therefore, if the flow of currency does not increase, there is a risk of deflation.

To curb that risk, as we explained, the state can decrease the production sold, but it is unpopular and abnormal, as society should constantly expands.

It is also possible to increase the velocity of circulation of money, but there is a limit.

The efficient solution is to increase the monetary mass: not too much (inflation risk), but enough to allow a regular increase in sold production (higher living standards)

The crucial choice is: should the state increase the monetary mass by creation of money or by debt ???

Of course, it is better for the state to create its own money (it's easy, it's just paper), but banks prefer creating the money (it's easy, just paper), and lending it to the state.

So it depends on the relative strength between public authorities and private banking.

Note that the vast majority of countries use only debt for decades... For example, the huge American deficit with Asiatic countries means China, Japan, India, ... actually lend hundreds of billions dollars to the US government for the war in Iraq.

Yet, even a strong state should not always create its own money: it's too easy and will hide poor productivity, old production process. 

monetary exchange

In my opinion, a better way to proceed is to create money to help financing recurrent social expenses (welfare) and reliable public infrastructures.

Other economic investments should be financed by public or private lending, with rates 1 or 2 percentage points above inflation rise, so as to make sure they are not wasted money, but generate enough productivity and profit to refund loans.

Here is the tree of life of a firm, a social organization, ... Organizing a firm like that should improve productivity.

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