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changed the location of conflicts. Terrorism may be con- Engler, Robert. 1961. The Politics of Oil: A Study of Private sidered a form of guerrilla warfare, in contrast to a set- Power and Democratic Directions. : Macmillan. piece war. In response to this shift in theaters and tactics, Library of Congress Business References Service. 2005–2006. Western governments alleged that certain Arab Muslim History of the Oil and Gas Industry. Business and Economics states were “sponsors” of these acts of terror or gave safe Research Advisor (BERA) 5/6. http://www.loc.gov/rr/business/BERA/issue5/history.html. haven to terrorists. Western states directed military and economic sanctions against these states, which included Mir-Babayev, Mir Yusif. Azerbaijan’s Oil History: A Chronology Leading Up to the Soviet Era. 2002. Azerbaijan International Iran, Libya, Sudan, Somalia, Afghanistan, and Iraq. It is 10 (2). not without significance that all these states either have Razavi, Hossein, and Fereidun Fesharaki. 1991. Fundamentals of petroleum reserves or stand athwart transportation routes Petroleum Trading. New York: Praeger. to world petroleum markets. Somalia, for example, con- Sampson, Anthony. 1975. The Seven Sisters: The Great Oil trols the approach to the Red Sea and the Suez Canal. Companies and the World They Shaped. New York: Viking. Since 1980 five major wars have been fought in the Snow, Keith Harman. 2007. The New Old “Humanitarian” region: the Soviet-Afghanistan War (1979–1989), the Warfare in Africa, Part II. Somali Times, February 7. Iraq-Iran War (1980–1988), the Persian Gulf War U.S. Department of Commerce, Census Bureau. 1975. (1990–1991), the U.S.-Afghanistan War that began in Historical Statistics of the United States: Colonial Times to 2001, and the U.S.-Iraq War that began in 2003. In addi- 1970. Bicentennial ed., pt. 1. Washington, DC: U.S. tion since 1980 U.S. naval ships and aircraft have block- Government Printing Office. aded and threatened to attack Libya, accusing it of being Wirth, John D. 1985. Latin American Oil Companies and the a state sponsor of terrorism. Politics of Energy. Lincoln: University of Nebraska Press. In 1991 the former republics of the Soviet Union Wirth, John D., ed. 2001. The Oil Business in Latin America: became independent. Several of them gave concessions to The Early Years. Washington, DC: Beard. Western companies to explore for petroleum. With these discoveries, proposals were made for pipelines to carry the Julian Ellison petroleum to shipping points for export to world markets. Three feasible routes exist for exporting Caspian Sea petroleum to world markets: west through Azerbaijan, Armenia, and Georgia to the Black Sea; south through POLICY, MONETARY Iraq and Iran to the Persia Gulf; or southeast through Monetary policy is the management of money, credit, and Afghanistan and Pakistan to the Arabian Sea. Overland interest rates by a country’s central bank. Unfortunately, markets are north into Russia and east into China. this short definition is clearly inadequate. What is money? All wars have as an objective the conquest of territory What is credit? What is an ? What is a central and its resources and assets, a major part since 1900 being bank and how does it control them? And, most impor- petroleum reserves. Thus all wars since 1900 may be con- tantly, why should anyone care? The purpose of this entry sidered, to some extent, wars to control oil. This objective is to answer these questions (for more detail, see the rele- has attained the highest priority since World War II, lead- vant chapters of Stephen G. Cecchetti [2006]). ing to increased military and diplomatic conflict. Petroleum wars may be expected to continue to arise until a different energy source is discovered and widely A FEW BASICS employed or until an effective international nonviolent Money is an asset that is generally accepted as payment for conflict resolution method is found and employed. goods and services or repayment of debt; money acts as a unit of account, and serves as a store of value. That is, peo- SEE ALSO Energy Industry; Industry; Iran-Iraq War; Iraq- ple use money to pay for things (it is a means of payment); U.S. War; Nationalization; Organization of Petroleum quote prices in dollars, euros, yen, or the units of our cur- Exporting Countries (OPEC); Resource Economics; rency (it is a unit of account); and use money to move State Enterprise purchasing power over time (it is a store of value). Credit is the borrowing and lending of resources. Some people BIBLIOGRAPHY have more resources than they currently need (they are Bilkadi, Zayn. 1994. Bulls from the Sea. Saudi Aramco World 45 savers) while others have profitable opportunities that (4): 20–31. they cannot fund (they are investors). Credit flows from Blair, John M. 1976. The Control of Oil. New York: Pantheon. the savers to the investors. And an interest rate is the cost Ellison, Julian. 1974. The Petroleum Industry in Africa and of borrowing and the reward for lending. Since lenders America. Occasional Paper no. 1974–1. New York: Black could have done something else with their resources, they Economic Research Center. require compensation—interest is rent paid by borrowers.

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THE CENTRAL BANK balance sheet, stripped of a number of incidental items The U.S. System, the Bank of Japan, and (like buildings and gold). When looking at any balance the Bank of England are all central banks. Nearly every sheet, the most important thing to remember is that assets country in the world has a central bank. It is easiest to equal liabilities, so any change in one side must be understand a central bank by looking at what it does (for matched by a change in the other. When a central bank a history of money and central banks, see Glyn Davies purchases a government security, increasing its assets, this [2002]). A modern central bank both provides an array of is normally matched by an increase in commercial bank services to commercial banks (it is the bankers’ bank) and reserve liabilities. Banks hold these reserves both because manages the government’s finances (it is the government’s they are required by law and in order to make interbank bank). While not universally true, we will assume that payments. only banks and governments have accounts at central At its technical, day-to-day level, monetary policy is banks. As the bank for bankers, the central bank holds all about buying and selling securities to control the quan- deposits accounts and operates a system for interbank pay- tity of reserves in the commercial banking system. ments that enables commercial banks (the ones the public Modern central banks, like the Federal Reserve or the uses) to transfer balances in these accounts to one another. European Central Bank, use their monopoly over the sup- The central bank is also in a unique position to provide ply of commercial bank reserves to control an interest rate loans to commercial banks during times of crisis—more of their choosing. In some, like the Reserve Bank of on this shortly. Australia, it is the deposit rate the central bank pays com- Like any individual or business, the government mercial banks on the balances in their reserve account. In needs a bank to make and receive payments. So, the cen- the United States, it is the federal funds rate—the rate tral bank keeps an account for the government. When the banks charge each other for overnight loans of reserves. government wants to make or receive a payment, it needs The Federal Reserve decides on its target for the federal a bank just like the rest of us. The central bank does that funds, and then buys and sells securities to set the supply job. In addition, the government gives the central bank the right to print money—that is the paper currency that of reserves to hit this target. Twenty-first century mone- people use in everyday life. tary policy is not about controlling the quantity of money or its growth rate; it is about interest rates. (For a techni- At its most basic level, printing money is a very prof- cal discussion of the use and the abandonment of money itable business. A $100 bill costs only a few cents to print, as a target, see Laurence Meyer [2001a]. For a detailed dis- but it can be exchanged for $100 worth of goods and serv- ices. It is logical then that national governments create a cussion of the monetary policy of the European Central monopoly on printing money and use the revenue it gen- Bank, see Otmar Issing et al. [2001]). erates to benefit the general public. Also, government offi- It is important to note that some central banks decide cials know that losing control of the money printing to use their ability to control the size of their balance sheet presses means losing control of . to target something other than interest rates. The natural alternative is the exchange value of their currency—that CONTROLLING MONEY, CREDIT, is, the value of the number of dollars it takes to purchase AND INTEREST RATES the currency issued by another central bank. But, by the beginning of the twenty-first century, this had become The fact that the central bank has the license to issue increasingly rare. A central bank cannot control the total money makes it unique. If individuals want to make a purchase, they need to have the resources to do it. So, for quantity of money and credit in the economy directly, and example, someone using a debit card to purchase groceries no modern central bank tries. will have to have sufficient balances in a commercial bank Finally, in addition to the size of their balance sheet, account to cover it. If the grocery purchaser does not have central banks have two additional tools. During times of sufficient resources of his own, he will need the financial financial stress, the central bank stands ready to provide assistance of someone who is willing to make him a loan. loans to banks that are illiquid (so they cannot make pay- The central bank is different. If the central bank wants to ments) but still solvent (so their net worth is positive). buy something—say a government-issued bond—it can Policymakers set interest rates on these loans. When the just create the liabilities to do it. Essentially it can issue the lending is done properly, this eliminates financial sys- money. Importantly, the central bank can expand the size temwide panics. In addition, central banks in many coun- of its balance sheet at will. No one else can do this. tries are given the power to set requirements governing The central bank uses its ability to expand (and con- how banks hold their assets. So, for example, they may tract) its assets and liabilities to implement monetary pol- require a certain level of reserve deposits, or prohibit the icy. Figure 1 is a simple version of the central bank’s holding of common stock.

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MONETARY POLICY OBJECTIVES low-risk alternatives, and the flow of resources from savers The central bank is part of the government. Whenever an to borrowers will stop. Getting a car loan or a home mort- agency of the government involves itself in the economy, gage becomes impossible, as does selling a bond to main- people need to ask why. What makes individuals inca- tain or expand a business. When the financial system pable of doing what they have entrusted to the govern- collapses, economic activity also collapses. ment? In the case of national defense and pollution regulation, the reasons are obvious. Most people will not THE POLICY FRAMEWORK voluntarily contribute their resources to the army, nor will Central banks use their ability to control their balance a country’s citizens spontaneously clean up their own air. sheet to manipulate short-term interest rates in order to The rationale for the existence of a central bank is keep inflation low and stable, the growth high and stable, equally clear. While economic and financial systems may and the financial system stable. But what makes monetary be fairly stable most of the time, when left on their own policymakers successful? Today, there is a clear consensus they are prone to episodes of extreme volatility. In the that to succeed a central bank must be: (1) independent of absence of a central bank, economic systems tend to be political pressure; (2) accountable to the public; (3) trans- extremely unstable. The historical record is filled with parent in its policy actions; and (4) clear in its communi- examples of failure, such as the Great Depression of the cations with financial markets and the public. 1930s, when the American banking system collapsed and economic activity plummeted. Independence is the most important of these elements. Successful monetary policy requires a long time horizon. Central bankers adjust interest rates to reduce the The impact of today’s decisions will not be felt for a volatility of the economic and financial systems by pursu- while—not for several years, in most instances. ing a number of objectives. The three most important are: Democratically elected politicians are not a patient bunch; (1) low and stable inflation; (2) high and stable real growth, together with high employment; and (3) stable their time horizon extends only to the next election. financial markets. Let’s look at each of these in turn. Politicians are encouraged to do everything they can for their constituents before the next election—including The rationale for keeping the economy inflation-free manipulating interest rates to bring short-term prosperity is straightforward. Standards, everyone agrees, should be at the expense of long-term stability. The temptation to standard. A pound should always weigh a pound, a meas- forsake long-term goals for short-term gains is simply uring cup should always hold a cup, a yardstick should impossible to resist. Given the ability to choose, politi- always measure a yard, and one dollar should always have cians will keep interest rates too low, raising output and the same purchasing power. Maintaining price stability enhances money’s usefulness both as a unit of account and employment quickly (before the election), but resulting in as a store of value. inflation later (after the election). Prices are central to everything that happens in a mar- Knowing these tendencies, governments have moved ket-based economy. They provide the information indi- responsibility for monetary policy into a separate, largely viduals and firms need to ensure that resources are apolitical, institution. To insulate policymakers from the allocated to their best uses. When a seller can raise the daily pressures faced by politicians, governments must price of a product, that is supposed to signal that demand give central bankers control over their budgets, authority has increased, so producing more is worthwhile. Inflation to make irreversible decisions, and long-term appoint- degrades the information content of prices, reducing the ments. efficient operation of the economy. There is a major problem with central bank inde- Turning to growth, central bankers work to dampen pendence: It is inconsistent with representative democ- the fluctuations of the business cycle. Booms are good; racy. Politicians answer to the voters; by design, recessions are not. In recessions, people lose their jobs and independent central bankers do not. How can people have businesses fail. Without a steady income, people struggle faith in the financial system if there are no checks on what to make their auto, credit card, and mortgage payments. the central bankers are doing? The economy will not oper- Consumers pull back, hurting businesses that rely on ate efficiently unless policymakers are trusted to do the them to buy products. Reduced sales lead to more layoffs, right thing. and so on. The longer the downturn goes on, the worse it The solution to this problem is twofold. First, politi- gets. cians establish the goals for the independent central Finally, there is financial stability. The financial sys- bankers, and second, monetary policymakers publicly tem is like plumbing: when it works, it is taken for report their progress in achieving those goals. Explicit granted, but when it does not work, watch out. If people goals foster accountability and disclosure requirements cre- lose faith in banks and financial markets, they will rush to ate transparency. While central bankers are powerful,

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elected representatives tell them what to do and then BIBLIOGRAPHY monitor their progress. Cecchetti, Stephen G. 2006. Money, Banking, and Financial The institutional means for assuring accountability Markets. New York: McGraw Hill–Irwin. and transparency differ from one country to the next. In Cecchetti, Stephen G., Alfonso Flores-Lagunes, and Stefan Krause. 2006. Has Monetary Policy Become More Efficient? some countries, such as the United Kingdom and Chile, A Cross-Country Analysis. Economic Journal 116 (4): 408- the government establishes an explicit numerical target for 433. inflation. In others, such as the United States, the central Davies, Glyn. 2002. The History of Money from Ancient Times to bank is asked to deliver price stability as one of a number the Present Day. 3rd ed. Cardiff, U.K.: University of Wales of objectives (for a discussion of the structure of central Press. bank objectives, see Laurence Meyer [2001b]). Issing, Otmar, Ignazio Angeloni, Vitor Gaspar, and Oreste Tristani. 2001. Monetary Policy in the Euro Area: Strategy and Decision-Making at the European Central Bank. Cambridge, THE FUTURE OF MONEY AND U.K.: Cambridge University Press. MONETARY POLICY Meyer, Laurence H. 2001a. Does Money Matter? The 2001 In the early 1980s, nearly two out of three of the countries Homer Jones Memorial Lecture, Washington University, in the world were experiencing inflation in excess of 10 Saint Louis, Missouri, March 28. http://www.federalreserve.gov/boarddocs/speeches/2001/2001 percent per year. In the early twenty-first century, this is 0328/default.htm. one in six. Two decades ago nearly one country in three Meyer, Laurence H. 2001b. Inflation Targets and Inflation was contracting. By 2005, five in six countries were grow- Targeting. Remarks at the University of California at San ing at a rate in excess of 2 percent per year. But not only Diego Economics Roundtable, San Diego, California, July has inflation been lower and output higher, both inflation 17. and output appear to be more stable. And careful empiri- http://www.federalreserve.gov/boarddocs/speeches/2001/2001 0717/default.htm. cal analysis shows that monetary policy is a likely source Meyer, Laurence H. 2001c. The Future of Money and of of this low, stable inflation and high, stable growth (see Monetary Policy. Remarks at the Distinguished Lecture Cecchetti, Flores-Lagunes and Krause [2006]). Program, Swarthmore College, Swarthmore, Pennsylvania, Central bankers’ success can be traced to their ability December 5. to control interest rates. And their ability to manipulate http://www.federalreserve.gov/boarddocs/speeches/2001/2001 1205/default.htm. interest rates relies on their control of the size of their bal- Sellon, Gordon H., Jr., and Chairmaine R. Buskas, eds. 1999. ance sheet. This, in turn, requires that banks and individ- New Challenges for Monetary Policy: A Symposium Sponsored uals actually demand central bank liabilities. That is, by the Federal Reserve Bank of Kansas City. Kansas City, MO: people have to want to hold the currency issued by central Federal Reserve Bank of Kansas City. banks, and commercial banks have to demand reserves. Won’t the day come when no one wants this stuff any- Stephen G. Cecchetti more? And when that happens, won’t monetary policy dis- appear? The answer is almost surely no. While it is true that the creation of a secure and anonymous substitute for POLITICAL CULTURE paper currency will ultimately cause dollar bills and euro Although insights into political culture have been part of notes to disappear, reserves are different. The central bank political reflection since classical antiquity, two develop- operates an interbank payments system based on reserves. ments in the context of the French Revolution laid the It does this to ensure that, even during periods of crisis, groundwork for modern understandings. First, when banks can continue to make payments. And to ensure that members of the Third Estate declared “We are the peo- commercial banks use their payments system, the central ple,” they were overturning centuries of thought about bank offers cheap access to this system—that is, it subsi- political power, captured most succinctly by Louis XIV’s dizes the cost of the system’s operation. So long as banks infamous definition of absolutism: “L’etat, c’est moi” (“I want reserves, there will be monetary policy (for a discus- am the State”). Henceforth, sovereignty was seen to reside sion of the challenges facing monetary policy makers, see in society rather than in the monarch and his divine Gordon Sellon and Chairmaine Buskas [1999] and rights. A century later, Max Weber turned this political Laurence Meyer [2001c]). claim into a scientific one when he defined legitimacy as that which is considered to be legitimate—not only by SEE ALSO Business Cycles, Real; Inflation; Policy, Fiscal; elites but by the population in general; to understand the Treasury View, The; Unemployment political power of the state, social science must therefore

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