Cash

Cash is commonly understood to be the physical form of money. While a vast array of physical items has been used in order to physically express money in the past, banknotes and coins are the predominant forms existing today. Bank deposits recorded on the liabilities side of banks' balance sheets are the original form of income that grant purchasing power to their holders. A banknote, on the other hand, is the physical acknowledgment that its holder is the owner of part of the central bank's liabilities. Banknotes therefore do not add to the bank deposits held by the public, but are a claim on existing bank deposits recorded on the liabilities side of central banks, commonly under the title "currency in circulation".

Efficient markets theory

Efficient markets theory, as formulated by Fama (1970, 1991), rejects the existence of unexploited profit opportunities in financial markets, arguing that the actions of profit-seeking traders will cause asset prices to reflect all available information. Acceptance of efficient markets theory implies nothing about whether financial markets coordinate investment and saving decisions in an orderly, socially optimal or stable manner, but only about whether it is possible for an investor to systematically "beat the market" (Tobin, 1984).

The weak form of efficient markets theory holds that knowing past asset prices will not enable an investor to follow a profitable trading rule. The semi-strong form holds that no publicly available information will enable an investor to beat the market, because all public information will have been already taken into account.

Central bank as fiscal agent of the Treasury

Throughout history, central banks have had a close working relationship with the Treasury of their country. While this cooperation changed with economic and political circumstances, the Treasury and central bank usually have worked together to promote economic and financial stability. The role of the central bank as a depository and fiscal agent of the Treasury is a central part of this close cooperation.

Today, as depository and fiscal agent of the federal government, a central bank pro- vides and manages a bank account for the Treasury. It monitors expenses and receipts to ensure that overdrafts do not occur (technically a central bank could provide an over- draft but the law usually forbids it). It collects and settles payments made to the Treasury (taxes, licenses, fines, and so on) and it clears checks drawn on the Treasury's account. The central bank is also responsible for the overseeing of the Treasury's transactions related to the public debt and to interventions in foreign-exchange markets. It oversees the bidding process, delivers treasuries to the bid winners, and credits the proceeds to the Treasury's account. It also redeems maturing treasuries, pays coupons, and oversees refinancing operations (Federal Reserve Bank of St Louis, 2004).

Central bank independence

Since the 1980s, we have witnessed a worldwide process of granting independence to an increasing number of central banks. Indeed, independence was the precondition for national central banks to join the European System of Central Banks in order for their countries to (eventually) join the euro area. The statute of the European Central Bank incorporates the idea of an independent central bank and even in many develop- ing and emerging market economies such as Turkey, South Africa or Zimbabwe, central bank independence (CBI) has become a central issue of economic governance reforms (see Acemoglu et al., 2008). Up until the global financial crisis that erupted in 2008, central bank independence was part of what has been dubbed the "great moderation": a reduction of inflation and output volatility since the 1980s allegedly due to structural market reforms, monetary reforms (including central bank independence) and "luck" (see Bernanke, 2012). Independent central banks appeared to be part of the solution to the time-inconsistency and political-business-cycle problems to which discretionary economic policy is prone.

Central bank bills

Central bank bills (CBBs) - also known as central bank securities or central bank bonds - are usually short-term (up to a year) financial instruments issued by a country's central bank or monetary authority to commercial banks. CBBs are primarily issued for a range of monetary policy purposes and exchange rate regulations, and are also used as a primary means of reducing excess liquidity (via reserves management).

While known to exist in various forms much earlier in monetary history, CBBs have found their widest application in developing and emerging markets in recent years, following a series of currency crises in the 1990s and most recently in the post-2008 crisis quantitative easing environment. CBBs may be used in conjunction with or in place of more typical liquid government securities (for instance Treasury bills, preferred in advanced economies) in a central bank's routine open-market operations. As such, CBBs are an increasingly important alternative monetary policy instrument.

The scope of CBBs is quite extensive, with both advanced and developing economies resorting to this instrument at different times (see, for example, Bank for International Settlements, 2009, 2013; Rule, 2011; Nyawata, 2012; and Yi, 2014), though advanced economies mostly rely on government-issued securities for their open-market opera- tions. A variant of CBBs can be used to finance a central bank's foreign reserves fund. For example, the Bank of England is known to have issued its own securities (euro and US dollar denominated) for such purposes. A similar approach, via a subsidiary, was adopted by Malaysia right after the 1997 Asian crisis. The Bank of Korea has used Monetary Stabilization Bonds (MSB) since 1961 as its primary means of absorbing excess capacity in the market (see Rule, 2011 for details).

As a liquidity management tool, the People's Bank of China (PBC), in 2003, started issuing short-term CBBs with up to a year in maturity. This policy has been maintained with successive reissuance, as a means to drain liquidity rather than monetary policy tightening. Importantly, targeted CBBs were issued for isolated commercial banks that saw high credit growth and liquidity levels on a relative scale. It is estimated that the PBC was able to sterilize up to 80 per cent of the liquidity increase between 2003 and 2007 (Bank for International Settlements, 2009).

In the post-2008 crisis quantitative easing policies' proliferation, Switzerland (in 2008) and Malaysia (in 2011) started issuing CBBs, used as eligible collateral by respective banks. At the same time, Argentina's central bank (in December 2013) started issuing 180-day maturity CBBs targeted at grain exporters in an effort to accumulate foreign reserves ahead of crop deliveries, with restrictions on resale and specific terms of bond redemption.

Dollarization

Dollarization is a monetary regime where a country adopts a foreign currency, usually the US dollar, as a means of payment for its residents' transactions, instead of its own domestic currency. Dollarization can be full or partial and, in most cases, it is imple- mented as a preferred choice for countries looking for monetary stability and protection from exchange rate volatility. Most countries that have dollarized their economy have done so during periods of economic instability. They also tend to have major economic links with the US economy whether through tourism, trade or as the recipient of significant US aid.

Full dollarization arises when a country completely abandons its own currency and adopts a foreign currency (very often the US dollar) in all its residents' financial transac- tions and dischargement of debt. All assets and liabilities are thereby denominated in that foreign currency; the national central bank stops issuing local currency. Ecuador is a noteworthy example, as it officially dollarized its economy in January 2000; El Salvador followed in 2001, while Panama dollarized in 1904.

Finance and economic growth

It is by now widely acknowledged that finance matters for economic growth and that the financial system may have an important impact on the speed and the stability of economic growth. Following "real analysis" (Schumpeter, 1954, p. 277) and hence the "classical dichotomy" between the "real" and the "monetary" spheres of the economy, classical, neoclassical and new classical mainstream economics consider that the growth of economic activity is determined by "real" forces only. However, there have always been dissenting views in the history of economic thought relying on "monetary analysis" (ibid., p. 278), in which monetary and financial factors matter for the determination of output and economic growth beyond the short run. Outstanding examples are the con- tributions by Marx (1894) on the role of credit for economic expansion and instability, by Schumpeter (1912) on the generation of credit "out of nothing" as a precondition for investment finance by innovative entrepreneurs triggering an economic upswing, and Keynes's (1933 [1987]) plea for a "monetary theory of production", as well as his clarifi- cations of the role of finance generated and provided by banks for economic expansion (Keynes, 1973).