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Precious Metals

Measuring the Quality of Money

Abstract: This article explains the theoretical importance of the quality of money as a factor of the demand for money and develops the composite indicator…

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This article was originally published by Mises Institute

Abstract: This article explains the theoretical importance of the quality of money as a factor of the demand for money and develops the composite indicator that measures the quality of money for the eurozone. The demand for money, i.e., the amount of money people keep in their balances, besides other well-known factors (e.g., interest rate, price level, and income) depends on how people subjectively perceive a particular money’s ability to serve its main functions: a medium of exchange, a store of value, and the unit of account. These properties depend not only on the instruments of monetary policy and the extent to which they are used, but also on the institutional framework of the monetary system. The article suggests that the quality of money is influenced by the institutional framework and monetary policy and that thus the quality of money is a separate channel for the transmission of money policy that works not through the usual mechanism of changing the supply of money, but through central banks affecting the demand for money. An important contribution of this article is that it develops an empirical composite indicator, which measures the quality of money in the eurozone in 1999–2019 and shows the gradual decline in the quality of the euro.

JEL Classification: E41, E52, E58, E51, E44

Vytautas Žukauskas ( is a PhD candidate in economics at the ISM University of Management and Economics and a senior policy analyst at the Lithuanian Free Market Institute. The author would like to thank Professor Guido Hülsmann and anonymous referees for their helpful and very constructive comments.


Monetary policy has an immense impact on the development of economies, and thus on the economic well-being of people. There are numerous studies investigating the channels through which central banks influence economies. How effectively certain goals may be achieved via monetary policy depends on how well we understand these channels and their relative importance. However, the recent emergence of unconventional monetary policy and vast expansion of financial markets calls for the revision of the standard view of monetary policy transmission channels.

The relationship between the demand for money balances and its determinants is a critical component in the formulation and transmission of monetary policy (Goldfeld 1994), especially because economic depressions and inflationary booms can be interpreted as caused by the disequilibrium between the supply1 of and demand for money (Yeager [1956] 1997).2

Various factors have been proposed as the determinants of the demand for money. Yeager ([1956] 1997, 5–6) claims that the demand for money essentially depends on the volume of transactions and on the price level, with interest rates, expectations, and business conditions also playing a role:

Households and businesses demand cash balances for what are usually classified as transactions, precautionary, speculative, and investment motives. Consideration of these motives shows that the total of cash balances demanded tends to be positively associated with the physical volume of transactions paid for in money (which depends in turn on payment practices and other institutional conditions, on the human and business population, and on the level of production or real income) and with the level of prices and wages. Interest rates and expectations of future price levels and business conditions also presumably have some effect on the demand for money.

Yeager ([1956] 1997, 7) compares money to any other commodity by saying that the number of money units that people demand varies inversely with the purchasing power as the value of the unit: we want to hold more units of any good if its value is higher. And as with other goods, there is some value or purchasing power of money unit that equilibrates the amounts demanded and supplied.

According to Laidler (1971), a stable demand function is a characteristic monetarist belief and is also supported by the empirical evidence. By “stable” Laidler means that money holdings “can be explained … by functional relationships which include a relatively small number of arguments” (Laidler 1982, 39).

In practice a “small” number of arguments has meant three or four—typically including a scale variable such as income, permanent income or wealth, an opportunity cost variable such as nominal interest rate or some measure of the expected inflation rate, and, if nominal balances have been the dependent variable, the general price level. (Laidler 1982, 39–40)

The liquidity preference framework emphasized the opportunity cost as the factor of the money demand. The demand for money depends on the tradeoff between the liquidity of holding money and the opportunity cost of holding it, which is the interest rate earned on holding less liquid but interest-earning alternatives.3 To this day authors name different factors in the demand for money balances, but the most prominent variables include the interest rate, level of income, price level, number of transactions, transaction costs, and the preferences of money holders.4

In the traditional framework, monetary policy works through changes in the supply of money. One of the defining features of monetarism is a “quantity theory” approach to macroeconomics, which is “a view that fluctuations in the quantity of money are the dominant cause of fluctuations in money income” (Laidler 1982, 3). Since the demand curve for money is downward sloping,5 an increase in the supply of money equilibrates the money market at the lower interest rate and higher quantity of money demanded.6 Shifts in the supply of money, interest rate, and the amount of financial assets held by market participants in turn affect the economy (and ultimately the aggregate demand) through different transmission channels.7

It is important that according to the traditional view the supply of money is essentially the key element through which central banks conduct the monetary policy. Monetary policy–induced changes in the supply of money are part of the transmission mechanism of monetary policy—the shifts in the demand for money are not.

This view is challenged by economists who suggest that central banks influence the demand for money through the quality of money. Hendershott (1969) claimed that the emphasis on the quantity of money and the Fisherian equation in judging the impact of monetary policy on the economy is misplaced, while its popularity stems from two factors: (1) the attractive simplicity of the naïve quantity theory and (2) historical correlations between money supply and output. Bagus (2009) argues that changes in the quality not only quantity of money are important for the demand and purchasing power of money. Quality of money is defined as the capacity of money, as perceived by economic actors, to fulfil its main functions, namely to serve as a medium of exchange, as a store of wealth, and as an accounting unit. According to Bagus and Howden (2016, 111), “As the purchasing power of money may change due only to a shift in the demand for money, the subjective valuation of money can change even with the expectation of a constant money supply.” Central banks influence characteristics of money (e.g., redemption of money and quality of the central bank’s balance sheet, conditions and stability of the banking system, organization and constitution of monetary authority), which determine actors’ preferences toward money. The quantity theory of money obscures the real problem at hand regarding the value of and demand for the monetary unit (Bagus and Howden 2016, 110).

More recently, Žukauskas and Hülsmann (2019) showed how monetary policy–induced the changes in the quality of money and shifts in the demand for money can explain the movements in the prices of financial assets. The reasoning is that the decline in the quality of money shifts the demand away from money to other assets (e.g., financial assets). They suggest a total-demand approach, which emphasizes the importance of quality of money for the reservation demand for money (demand by the holders of money). The notion of quality of money may shift the understanding of how central banks influence the economy. If it is correct, then theorists will need to accept that monetary policy works not only through the supply but also through the demand side of money.

There has been some discussion of the dimensions of monetary policy which may impact the quality of money and thus the demand for money.8 However, there have not been any attempts to measure this impact. The notion of the quality of money stems from the subjective value theory, in which the qualities that determine the value of objects are subjective and are hard to quantify. The absence of measurement makes it difficult to judge the importance of quality of money as a demand-side channel of monetary policy. This paper attempts to fill this gap. It will discuss the dimensions of monetary policy that are relevant for the notion of the quality of money, and it will quantify them by compiling a composite indicator of the quality of money.

The first part of the article will discuss the theory behind the subjective nature of the value and demand for money. The second part will focus on the quality of money. The third part will cover the methodological issues in compiling the composite indicator. The fourth part will present the results of the index. The fifth part will discuss the limitations and the importance of the quality of money and its measurement in the context of monetary policy.


The theory behind monetarism and the stable money demand function tends to overlook the subjective nature of the demand for money. The quantity theory of money as formulated by Fisher (1911) and restated by Friedman (1956) still dominates the way economists look at the purchasing power of money. This theory focuses on the supply of money, and it does not explicitly suggest a role for the subjective factors which determine the demand for money. “While such an analysis is not obviously incorrect, the attention the equation affords to past quantities, both of money and nominal transactions, obscures the real problem at hand regarding the value of and demand for the monetary unit.” (Bagus and Howden 2016, 110).

The qualitative (or demand-side) approach is older than the modern focus on the quantitative (supply-side) factors in the analysis of the value of money:

A long history of qualitative and demand-side analysis predates the modern attention to supply-side factors determining money’s value. Early authors such as Mariana ([1609] 1994) and Petty (1662) illustrate this long tradition of the quality theory of money. Smith ([1776] 1863) explains the origin of money by pointing to the importance of certain qualities such as a commodity’s divisibility and durability. Similar discussions of the qualities of a “good” medium of exchange are found in the classic works of Say ([1803] 1843), Mill ([1848] 1909), and Senior ([1850] 1854). Menger ([1871] 2007) explained the origin of money as a market process whereby commodities with certain marketable qualities prevail at becoming generally accepted exchange media. By the time Jevons ([1875] 1876) wrote his treatise Money and the Mechanism of Exchange, the characteristics or qualities of “good” money were generally known (and are still today summarily detailed in most introductory monetary economics texts). (Bagus and Howden 2016, 111–12)

Some economists, predominantly those in the Austrian school of economic thought, clearly recognize that the demand and value of money are subjective and that they stem from money’s ability to fulfil its functions in the market (medium of exchange, store of value, unit of account). To be properly used as money, a good must have certain characteristics. Classically, these are divisibility, fungibility (or universal want), durability, and stability of value.

Mises in the Theory of Money and Credit and Human Action explained how prices and the value of money can be explained using the same principles used to explain the prices and value of other goods in the economy. The price of money is its purchasing power, and it emerges in the market as a result of the demand for and the supply of money (the so-called money relation). It is clear that according to Mises the demand for money is subjective. Catallactics can tell us about the advantages of holding money and about the factors which may influence the demand for money, but the demand for money can never be reduced to a specific function.

But all of these objective factors always affect the matter only as motivations of the individual. They are never capable of a direct influence upon the actual amount of his demand for money. Here, as in all departments of economic life, it is the subjective valuations of the separate economic agents that alone are decisive. The store of purchasing power held by two such agents whose objective economic circumstances were identical might be quite different if the advantages and disadvantages of such a store were estimated differently by the different agents. (Mises [1934] 2012, 154)


The various actors make up their minds about what they believe the adequate height of their cash holding should be. They carry out their resolution by renouncing the purchase of commodities, securities, and interest-bearing claims, and by selling such assets or conversely by increasing their purchases. With money, things are not different from what they are with regard to all other goods and services. The demand for money is determined by the conduct of people intent upon acquiring it for their cash holding. (Mises [1949] 1998, 401)

The subjective demand for money is closely linked to the recognition that money is a good. Like any other good, money is demanded by the market participants for its valuable services. Hutt (1956) explains that money should not be considered unproductive or barren, as was claimed by many influential authors (e.g., Aristotle, Locke), who influenced modern thinkers. Keynes claimed that by choosing to hold money for convenience and security market participants are foregoing the interest that could be earned by holding other assets which bring nothing “in the shape of output” (Keynes 1936, 226). However, according to Hutt, money is productive in exactly the same sense as other goods in the economy. Money assets held provide valuable services, and they derive their value from their power to render these services. The amount of money that market participants decide to hold is determined by the marginal utility of its services. In fact, this means that money has a “prospective yield (of ‘utilities’), which invites the holding of money, as the normal return to investment” (Hutt 1956, 198). The demand for money is effectively the demand to hold. It stems from the value of being in a position to acquire other things at “the most profitable time, or at the most convenient time” (Hutt 1956, 206). Thus, holding money is not forgoing the yield which could be earned by holding other interest-bearing assets. By holding money, one earns a nonpecuniary yield in the form of money services.9

The services that the owner receives from holding money are related to the uncertainty in the market economy. Rothbard ([1962, 1970] 2009, 767) recognizes that the demand for money emerges from the uncertainty that economic agents face: money’s “uses are based precisely on the fact that the individual is not certain on what he will spend his money or of the precise time that he will spend it in the future.” Although these uses are objective in the sense that every economic agent faces uncertainty, the demand for money is still subjective:

Economists have attempted mechanically to reduce the demand for money to various sources. There is no such mechanical determination, however. Each individual decides for himself by his own standards his whole demand for cash balances, and we can only trace various influences which different catallactic events may have had on demand. (Rothbard [1962, 1970] 2009, 768)

An important contribution of Rothbard is his application of total demand and stock analysis to the analysis of money and the purchasing power of money. Money is unique in the sense that people simultaneously have a reservation and exchange demand for money. As Rothbard ([1962, 1970] 2009, 757) noted, “In contrast to other commodities, everyone on the market has both an exchange demand and a reservation demand for money.” The total demand for money on the market consists of two parts: the exchange demand for money (by sellers of all other goods who wish to purchase money) and the reservation demand for money (the demand for money to hold by those who already hold it) (Rothbard, [1962, 1970] 2009, 756). Exchange demand for money is the pre-income demand, and reservation demand for money is the post-income demand. Individuals demand money that they do not yet own by offering their goods or services in return for money—this is the exchange demand for money. Individuals also demand money that they own by choosing to not spend it and keep it in their cash balances—this is the reservation demand for money.

The price level is determined by the intersection of the total demand and the total stock of money. The total-demand and stock analysis utilized by Rothbard is an elegant analytical tool which clearly shows the errors inherent in the quantity theory of money, which assumes a mechanistic relationship between the supply of money and prices. Both the exchange and reservation demand for money are subjective, thus an increase in the supply of money can produce different effects on prices depending on how people react to this change, by deciding to hold a higher or lower share of additional money in their money balances.

An important question is which one—exchange or reservation demand—is more important for the determination of prices and the purchasing power of money. According to Rothbard ([1962, 1970] 2009, 759), the reservation demand for money is more important because it is “more volatile.” The volatility of the reservation demand comes from the fact that holders of money may, for some reason (e.g., they think that the purchasing power of money will go down), want to drastically reduce their holdings of money by spending them. They cannot reduce their exchange demand for money so easily, because it is a lot easier to spend their cash balances than to turn to exchanging their goods and services for nonmonetary goods (barter) or other competing money in the market. Thus, the importance of the reservation demand for money comes from the fact that it is more volatile and thus more important in the changes in prices and the purchasing power of money. However, precisely because it is more stable, an argument can be made that exchange demand for money, i.e., the supply of goods and services, has an important influence on the purchasing prices and power of money, at least in the short run. Even if the reservation demand for money decreases significantly, the exchange demand for money can stay relatively stable and keep the prices and purchasing power of money from dropping rapidly.

Horwitz (1990) applies subjectivist principles to the demand for money as well and criticizes as oversimplified “neoclassical and Keynesian models that portray the only opportunity cost of money held as interest-bearing securities.” His approach claims that the choice to hold money depends on the utility of the most valuable alternative forgone:

When an actor is facing a decision to hold wealth in the form of money, she is deciding between a number of prospective utility streams. We can broadly categorize those streams as the utility from non-financial assets and the utility from both the availability and interest returns from non-money financial assets. (Horwitz 1990, 465)

Most importantly, the demand for money is subjective, since only the chooser can determine the utility that their choice provides. Moreover, the cost of holding money is subjective, because it is never objectively realized.

What is given up in a choice is by definition what was not chosen, so the “measure” of that cost must necessarily be the expected utility of the sacrificed alternative. Such expectations can be definitively described only by the chooser. (Horwitz 1990, 465)

The subjectivity of the demand for money brings us back to the monetary policy. If the demand for money balances has an important subjective element to it, the demand for money can be influenced, but it is not mechanically determined by such factors as income, price level, or interest rate. If this is the case, then central banks and monetary policy may not just influence the amount of money that people are willing to hold through the manipulation of the money supply and the interest rate. The subjectivist approach to the demand for money allows for the recognition that the impact of central banks on money (and prices) may be much broader. And this is exactly the claim of the recent literature on the quality of money.


The theory of the quality of money maintains that the demand for money depends on the quality of money. Money’s quality can be defined as “the capacity of money, as perceived by actors, to fulfil all its main functions, namely to serve as a medium of exchange, as a store of wealth, and as an accounting unit” (Bagus 2009, 22–23). The quality of money is one of the important factors, along with uncertainty, financial innovations (credit cards, ATMs, money market mutual funds), frequency of payment, etc. that affect the reservation or cash balance demand for money (Žukauskas and Hülsmann 2019).

Money supply, according to this view, is just one of the factors affecting the quality of money. Existing total supply of money at any time does not matter in the sense that money can be used as a universal medium of exchange despite the amount of monetary units available (a lower amount just means a lower price level). Money supply matters for the quality of money if we add the dimensions of time and changes in the supply of money. Changes in the supply of money influence the extent of the stability of the purchasing power of money. However, there are a lot more factors or dimensions influencing the quality of money: “As the purchasing power of money may change due only to a shift in the demand for money, the subjective valuation of money can change even with the expectation of a constant money supply” (Bagus and Howden 2016, 111).

The idea behind the quality of money is that central banks, through monetary policy, influence other characteristics of money (besides money supply) that are relevant for money users. A shift in these characteristics impacts the quality and subjective value of money, and “[c]hanges in money’s quality affect the demand for money and, consequently, its purchasing power” Bagus (2015, 19).

According to Bagus, “good” monetary systems have objective qualities. The quality of a money is closely linked to the quality of the monetary regime, which can be defined as “the capacity of a monetary system to provide an institutional framework for a good medium of exchange, store of wealth, and accounting unit” (Bagus 2015, 19–20).

According to Bagus (2015), the unit of account function is fulfilled by nearly all monetary systems equally well, and it is impaired only in extreme situations. Thus it is meaningful to concentrate on the characteristics of a good medium of exchange and store of value.10 The main requirements for money as a medium of exchange are low storage and transportation costs, easy handling, durability, divisibility, resistance to tarnish, homogeneity, and ease of recognition. However, “These properties hardly change today as paper-based fiat standards have eased the physical usability of the monetary unit, as well as the costs to provide it” (Bagus 2015, 23). Another relevant property of a medium of exchange is the number of users, because more users imply more demand for the medium of exchange. “As more people accept it in trade, the medium of exchange is more useful” (Bagus 2015, 23). Existence of ample nonmonetary demand for the money as either a consumer good or a factor of production is yet another important characteristic for a medium of exchange. However, in fiat money systems, where money is not redeemable, it does not have this property altogether.

One of the most important variables in money’s function as a store of value is the possibility of increases in its quantity. “Different monetary regimes allow for different mechanisms to increase the quantity of money, thereby influencing money’s quality. Thus, monetary systems may set strict or less strict limits for increases in the money supply” (Bagus 2015, 24). The stability of the financial system is also an important property of money and a factor in its store-of-value function.

There are monetary regimes that are more prone to generate business cycles, over-indebtedness and illiquidity than other regimes. Business cycles, over-indebtedness and illiquidity may provoke interventions and bailouts on the part of the government or monetary authorities. In the wake of the bailouts the quantity of money is often increased, or even the quality of the monetary system is diluted. (24)

The monetary regime’s independence from the government and the restrictions that it sets to eliminate or limit the government’s manipulation of money are also important to money as a store of value. “Interventions by the government often decrease the quality of money in its own favor by increases in money’s quantity or through a deterioration in the reserves backing it” (25).

To sum up, the quality of money as a store of value and a medium of exchange can essentially change in five ways (Bagus and Howden 2016, 113):

  1. Money supply—the supply of money in existence today and in the future
  2. Redemption ratio (in the case of commodity money systems)—the amount and value of assets or other goods that back the currency (that money can be redeemed for)
  3. Conditions and stability of the banking system—a financially troubled, illiquid banking system increases risk of bailouts, which may lead to higher quantity of money (if financed through debt monetization)
  4. Institutional framework of the monetary authority, which can mean: 

    a. The independence of the central bank (if the central bank follows directives from the government, this increases the risk of debt monetization to finance spending)

    b. Accountability and transparency—–the quality of money will improve if central bankers are accountable and responsible for their policies and if there is transparency

    c. The central bank’s constitution, that is, its philosophy or objectives (e.g., price stability versus ancillary aims of full employment, increasing asset prices, and maintenance of a currency), its price inflation target, whether it has a rule-based monetary policy or simply targets asset prices

    d. Staff and decision-makers at the central bank, who influence monetary policy primarily through building consensus

  5. Quality of the central bank’s balance sheet—the quality of the reserves and assets backing the money determines the central bank’s ability to maintain and defend the currency’s value in the future

Therefore, by incorporating the quality of money, it is possible to understand how the purchasing power of money can vary with a constant money stock, namely when the perceived quality of money changes. The quality of money affects the purchasing power of money by first altering the demand for money, which reflects the changed valuation of a fixed quantity of money on each person’s value scale. When the quality of money improves, the demand for money, and, consequently, money’s purchasing power, will be higher. If subjective valuation of money falls, people will reduce their cash balances and prices will increase. The subjectivity of valuation and demand for money also means that changes in the perceived quality of money can be very abrupt (which would lead to a strong and quick change in the purchasing power of money), whereas changes in the quantity of money are usually gradual.


Based on the framework discussed above, this section will develop an empirical composite indicator for the quality of money and apply it to the euro area. “Composite,” also known as “synthetic,” indicators are “formed when individual indicators are compiled into a single index, on the basis of an underlying model of the multi-dimensional concept that is being measured” (Nardo et al. 2005, 8). Essentially, a composite indicator consists of numerous “components” that reflect a “complex system,” making it easier to understand in full rather than by reducing it to its “spare parts” (Greco et al. 2019). The literature on composite indicators suggests a particular procedure to compile a composite indicator. We will analyze the quality of money using these steps.

Theoretical Framework

The first step in the creation of a composite indicator is the theoretical framework, which establishes what is being measured, its measurable dimensions, and eventually the indicators that constitute the composite indicator. The strength of the theoretical framework determines how meaningful the composite is. The quality of money and its measurable dimensions have already been discussed above. Here we will focus on the indicators.

The selected indicators must carry relevant information about the core components of the phenomenon being measured. Practitioners use proxy variables when direct indicators or data are not available (OECD and JRC 2008). Although the selection of indicators is vested in the theoretical framework, practitioners admit that it is a process which depends on the judgments of the researcher.11

The selection of the indicators for the quality of money index and the dimensions of it was heavily influenced by the existing scholarship on the quality of money, which has been discussed above. As shown in table 1, the index consists of five dimensions and eighteen indicators. The indicators in the central bank balance sheet dimension follow the suggestions of Bagus (2015) and Bagus and Howden (2016). The rest of the indicators were selected to reflect the other significant aspects of the quality of money. The choice of dimensions and indicators will be discussed below.

The Central Bank Balance Sheet

The quality of money can be measured indirectly by the assets that back the monetary base. Central bank assets serve as collateral that “backs” the currency and represents the central bank’s capability to defend the value of the currency domestically and internationally. The balance sheet will be assessed by three liquidity ratios, two international strength ratios, and one equity ratio (see table 1). The idea behind the liquidity ratios is that the higher the share of liquid and high-quality assets in the central bank’s reserves, the higher the quality of money will be. During a crisis, liquid assets can be used to support a faltering currency. International strength ratios indicate a central bank´s potential to defend the external value (i.e., the foreign exchange rate) of a currency. International strength ratios show the percentage of monetary liabilities that are backed with foreign reserves, which can be used to support the currency’s value on the foreign exchange market. The equity ratio indicates the central bank’s leverage. A higher ratio implies a more conservative situation (i.e., less leverage) and an increased quality of money.

Money Supply

Changes in the money supply is one of the factors influencing the quality of money. Existing total stock of money at any time does not matter in the sense that money can be used as a medium of exchange despite the number of monetary units available. However, changes in the money supply influence the long-term stability of the purchasing power of money. The index contains four indicators that represent different definitions of the money supply: monetary base, central bank balance sheet, and monetary aggregates M1 and M3.

Interest Rates

There is a link between money supply and interest rates. The European Central Bank (ECB) communicates its monetary policy stance by setting an interest rate target. This target is achieved primarily through open market operations—by purchasing or selling financial assets in the market and thus increasing or decreasing the monetary base. Thus, changes in the interest rates set by the central bank show how inflationary its monetary policy is. A decrease in the interest rates is achieved through an increase in the money supply, which in the long term means a lower purchasing power of money. The quality of money index contains four indicators measuring interest rates. Three of them represent three key interest rates set by the ECB: the rates on the deposit facility, the main refinancing operations (MRO), and the marginal lending facility. The fourth indicator is based on spread between the main refinancing operations rate and Taylor’s rule interest rate.

Taylor’s rule is a guideline for how central banks should change interest rates in response to changes in economic conditions. It was established to adjust and set prudent rates for the short-term stabilization of the economy while still maintaining long-term growth (Taylor 1993). Machaj (2016) admits that Taylor convincingly demonstrates that low interest rates contributed to the housing bubble and mortgage market expansion. However, Machaj (2016, 12) criticizes the Taylor rule from an Austrian perspective by saying that “any rule recommended for interest rates higher than the actual ones would have been better than that actually followed (even a rule based on astrology). Apart from that, there may be nothing specific about the Taylor rule that makes it a panacea for macroeconomic problems.” The technical problem with the Taylor rule is that it has many variants and that it cannot be applied precisely (e.g., it is difficult to measure the potential output). The fundamental problem is that following this rule does not ensure economic stability: “[T]argeting … macroeconomic variables is not a recipe for intertemporal coordination understood in the Hayekian sense: as coordination between successive stages of production” (Machaj 2014). Nevertheless, in this indicator we will use the Taylor rule as a rough guide and the basis for the evaluation of the interest rate set by the monetary authority. Following the Taylor rule does not ensure macroeconomic balance, but it is quite clear that strong deviations from it are related to macroeconomic imbalances.

Financial System Stability

The conditions and stability of the financial system matter for the quality of money, because a financially troubled, illiquid banking system increases risk of bailouts, which may lead to a higher quantity of money (if financed through debt monetization). The stability of the financial system is measured by three indicators: the Composite Indicator of Systemic Stress (CISS), the euro interbank offered rate–overnight index swap rate (Euribor—OIS) spread, and the liquidity ratio of the eurozone banking sector (for a more detailed explanation of each indicator, see table 2).

Forward Guidance

Forward guidance is central bank communication—announcements, speeches, press conferences—which aims to provide information about the likely path of future policy and interest rates (Kuttner 2018, 126). Forward guidance is an unconventional instrument of monetary policy that the ECB uses to guide the expectations of market participants about the future stance of monetary policy. Forward guidance is connected to the quality of money: expectations for prolonged periods of inflationary monetary policy mean that market participants expect the interest rates to stay low and the money supply to increase faster than otherwise. The index contains one indicator (the spread between current rate of main refinancing operations and the OIS rate) which captures the extent to which market participants expect monetary policy to remain or become inflationary (see more in table 1).

Table 1. Indicators of the quality of money index