The Financial System: Creating and Destroying Money

This post will describe the way the simulation will incorporate finance.  The structures described here are not necessarily exposed to a casual player, but there are a number of variables that can be tuned by external developers to appropriately balance the economy.  Additionally, there is no reason why policies cannot be implemented to allow direct control of this higher level of the economy if that level of micromanagement is desirable to others.  More than anywhere else, the tuning of the financial system of the game will be a delicate task and some robust tests will be required by external developers to make it work!

The financial system will suffer from some criticisms:

• lack of absolute realism:  sorry about that, but there have to be some limits.  So, for example, there is no concept of investment banking, stock markets, or anything else.  It may be possible to add these later, but they provide too much complexity in a first version.
• over-complexity:  even a simple financial system will appear complicated.  Again, I emphasise that this needn't be available for the player to see, but will make the actual economic cycle a bit more realistic (hopefully!)

So, if you are sitting comfortably, then we'll begin.

The State


The State is simply the ultimate root of the entire economy, and can be broken into two halves as shown in the picture below:

The Government is the element in day-to-day control of the player - the levels of spending (an outgoing amount of money from the city accounts) and taxation (the incoming funds) are directly influenced by the player's activities and policies.

The Central Bank represents a very simplistic version of its real-world counterpart.  As we shall momentarily see, the simulation will include regular retail banks within the economy.  In WorldSim, the Central Bank will require each Bank to deposit a certain minimum percentage of its funds with the bank at the end of each working day.  The Central Bank will apply a certain interest rate to these deposits, and returns the total to the bank.

So already, we have introduced two variables into the economy:

• The minimum percentage deposit by each retail bank
• The Central Bank's interest rate

These two variables represent one control on the amount of money in the economy.  If the interest rate is positive, the Central Bank will be creating money in the economy, but will similarly destroy money in the economy if the rate is negative.  In that sense, it promotes inflation and deflation, and the Central Bank's interest rate can be controlled by a policy.

It should obviously be noted that this is an incredibly crude oversimplification of the role of a central bank in the role of interest rates, but hopefully it will be sufficient.  To the Central Bank's role, we will also add the job of loaning money to the Government - how this is achieved in practice will be described when we discuss loans below.

Retail Banks
These banks have more of a direct influence on the day-to day running of the economy - they take deposits from individuals and companies, and make loans to the same.  All the while, they interact with the Central Bank in the way previously described.  Their basic structure is shown in the below diagram, but all the decisions about aspects such as the making of loans are subject to scripting provided by myself or external developers and to any applicable policies imposed by the player.

There can be as many of these banks as is desired within the simulation, each with their own distinct policies on making loans, offering interest to their depositors, etc.  They can be aware of each other and compete accordingly.  Loans are merely a specialisation of a service to be sold within the economy - and all services depend on contracts.


We will define a contract generically as an object that has the following properties:

1. Providing party
2. Receiving party
3. Frequency - how often is payment made/service provided
4. Period - how long does the contract last
5. Items provided
6. Payment made by receiving party
7. Penalty for contract violation by providing party
8. Penalty for contract violation by receiving party

A violation simply occurs when one or other party does not provide the items or the payment required of them.  Contracts will allow services to become as important in the economy as physical goods - as in real life, tangible goods are not required.  We will discuss this in more detail in a later economic post.

For now, it is sufficient that loans are a contract made in exchange for the bank providing someone with a sum of money.  In this instance, the payment frequency would be monthly, but no items would be provided (the lump sum would be paid in advance of the contract being made), and the payment made would correspond to a loan repayment with any interest needed.

Such loans will be useful for companies and individuals within the simulation.  Our retail banks will run on a system of fractional-reserve banking, where a bank must only retain a fixed percentage of their deposits and may loan the rest.  This will drive additional creation of money in the economy, and is another variable that may be determined by external developers or determined by a policy.  Fractional-reserve banking can be turned off by setting the retention percentage to 100%.

A player may borrow funds from the Central Bank on similar terms to these, with a fixed repayment period, repayment amount and interest rate. A final note is that the government will always possess a dormant retail bank, which will allow us to easily allow the player to embark on radical policies such as nationalisation of banking.

Please comment - I'm sure there's a lot of detail needs ironing out here.  I'll continue the posts as planned earlier in a few days

Fred