Sir Mervyn King: Banks Create Money

Sir Mervyn King, Governor of the Bank of England, in the recent speech to the South Wales Chamber of Commerce at The Millenium Centre, Cardiff on 23 October 2012 was talking about the role of banks in creating the nation’s money supply – the aspect of banking which is still poorly understood among the policymakers and economists:

[sws_blockquote align=”” alignment=”” cite=”Sir Mervyn King” quotestyles=”style02″]When banks extend loans to their customers, they create money by crediting their customers’ accounts. [/sws_blockquote]

Here is a short extract:

The usual role of a central bank is to limit this rate of money creation, so that an excessive expansion of money spending does not lead to inflation. But a damaged banking system means that today banks aren’t creating enough money. We have to do it for them.

Over the past three years, the Bank of England has bought £375 billion of government bonds – gilts – from the private sector to create a lot of new money. Many – perhaps some of you – are understandably concerned about the use of such an unusual and unfamiliar policy. Some people talk about the dangers of money creation. I want to explain why it is important to distinguish between “good” and “bad” money creation. In essence, the argument is very simple. “Good” money creation is where an independent central money creation is where an independent central bank creates enough money in the economy to achieve price stability. “Bad” money creation is where the government chooses the amount of money that is created in order to finance its expenditure. Insufficient money creation can lead to a contraction of the money supply and a depression. We saw that in the United States during the Great Depression and we see it today in Greece. Excessive money creation leads to accelerating inflation and ultimately the collapse of the currency.

The role of the Bank of England is to create the right amount of money, neither too much, nor too little, to support sustainable growth at the target rate of inflation. We are not doing it at the behest of the Government to help finance its spending. It is the independence of the Bank that allows us to create money without raising doubts about our motives. But just as it is crucial that governments do not control the printing of money, so too the unelected central bank must not determine the levels of taxes and public spending. Fiscal policy is a matter for elected governments.

Read the whole speech here.

Watch the video here: