Making money

Trading Money
Banks buy and sell money, just like rice-vendors buy and sell rice or bookshops buy and sell books. Money is a commodity. It can be hoarded just like rice. When rice is hoarded, its price will go up. Central banks control money supply by taking monopoly in the issue and price of money, and creating oligopoly in the private bank businesses allowed to trade in money. The discount rate is the price private banks pay to the central bank. A 3% discount rate means private banks pay 103 for every 100 money bought from central bank.

Causing inflation or deflation of the real economy.
By lowering the discount rate to 2.7%, central bank increase primary money supply, It decreases money supply by increasing the discount rate to 3.3%. Banks buy and sell money with each other at the base rate, which reflects the banks' cost above the discount rate. When banks hoard money, it is known as money refraction or 'mopping up of excess liquidity'. It causes people to not have enough money for their daily transactions, so they raise market prices of rice, books, etc in order to get more money. Consumers' salaries and wages become insufficient to meet survival needs so they work increased hours or ask for increased earnings or both. If successful, business costs rise, so businesses must increase product prices or product volumes or both. The increase in business costs is called inflation. If consumers or businesses fail to increase prices, demand for product or labour will fall. This is called deflation.

Interest rate
Consumers or businesses who cannot get higher prices face the risk of defaulting on their bank loans. Having caused the problem in the first case, banks make more profit through continuing to withhold money supply and charging fees on borrowers who default on loans or by raising the cost of money to borrowers. This cost of money is called the interest rate.

Credit crunch
Whenever the real economy is producing sufficient money for businesses or consumers to meet their needs without increasing prices, they do not borrow money from the banks. So banks do not get new assets on which to earn interest. Banks then reduce credit terms to make money cheaper or lower their interest rates paid on deposits in order to discourage savings. This causes more money to be available to producers and labour-ers. They increase prices (money demand) in order to obtain the increased money supply, Those who cannot increase prices sufficiently, must borrow from the banks. Inflation ensues. By strengthening credit terms, banks reduce money supply. Borrowers may not be able to increase the prices to meet their loans. This is a 'credit crunch'. The banks crunch (put the screws on) the over-extended borrowers. It is a crisis for the borrowers.

Credit crisis
Remember that banks trade in money? Banks that borrowed (took deposits) from other banks have to pay their creditors. When a borrower bank cannot pay its creditor banks, this is a 'credit crisis'. It is a crisis for the banks because they all kept only 2% of the money they lent to each other and to their borrowers. If one bank fails, its obligations to its creditor banks cannot be met and so they may fail too, and so may their creditors...