Money Creation


The New Economics Foundation (nef) have published a guide to the UK monetary and banking system with the title ‘Where Does Money Come From?’. It contends that there is widespread misunderstanding of how new money is created, which may imply that the only widespread understanding of ‘money’, lies in its purchasing power. Drawing such an inference from the book seems reasonable.

There is a wide assumption that those in the financial world know what they are doing, that the fiscal policy implemented by a public administration will work. That somehow the Chancellor of the Exchequer, the Government and the Bank of England, will always sort things out. Ignoring a history that tells us government fiscal policies always reduces the purchasing power of money.

Microeconomics-quote-P-J-ORourke

Most view money as being cash, either in hand or on deposit in a bank. Available ‘credit (debt)’ may be regarded as being cash inasmuch as it can be used to make a purchase. In reality most monetary activities could be seen as being synonymous with those of a commercial bank. However, non commercial banking monetary activities by a private individual, are for the most part, limited by a commercial bank controlling access to debt. So controlled the flow of money into the economy that a private individual may inject. Nevertheless, like a commercial bank, a private individual may have one or more of the following:

The nef guide identifies national currency as existing in the three main forms shown below, the second two of which exist in electronic form. Only the Bank of England or the Government can create the first two forms of money. Central bank reserves do not actually circulate in the economy. Therefore out of the following sources of ‘money’ , the only supply of money circulating consists of 1. and 3, which are cash and commercial bank money.

  1. Cash – banknotes and coins.
  2. Central bank reserves – reserves held by commercial banks at the Bank of England.
  3. Commercial bank money in the form of:
  • bank deposits created when the banks lend money, crediting credit borrowers’ deposit accounts,
  • bank deposits created when payments made on behalf of customers using their overdraft facilities,
  • assets purchased from the private sector,
  • payments made on their own account (such as salary or bonus payments).

1. Cash accounts for less than 3 per cent of the total stock of money in the economy.

3. Commercial bank money – credit and coexistent deposits – makes up the remaining 97 per cent of the money supply.

Defining money is surprisingly difficult, but may be taken to be; “anything widely accepted as payment, particularly by the government as payment of tax, is, to all intents and purpose, money”.

7 responses to “Money Creation

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