Bank of England on Money and Money Creation in the Modern Economy

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Where does money come from?  In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood. The principal way in which they are created is through commercial banks making loans: whenever a bank makes a loan, it creates a deposit in the borrower’s bank account, thereby creating new money.  This description of how money is created differs from the story found in some economics textbooks. 

Believe it or not, this is an extract from the News Release on new Quarterly Bulletin on Bank of England’s website!

We’ve been talking about the way money is created for the last 4 years. We’ve also argued that the textbooks used in universities were inaccurate. At last, there’s an official document and videos that we can send to all those economists, academics, politicians and everyone  who still shake their head when we’re explaining this.

Here are the papers and videos:

Screen Shot 2014-03-12 at 15.26.17 Money in the modern economy: an introduction (531KB)

This bulletin provides an introduction to the role of money in the modern economy. It does not assume any prior knowledge of economics before reading. The article begins by explaining the concept of money and what makes it special. It then sets out what counts as money in a modern economy such as the United Kingdom, where 97% of the money held by the public is in the form of deposits with banks, rather than currency. It describes the different types of money, where they get their value from and how they are created.


The book “Where Does Money Come From?”, co-authored by Positive Money’s Head of Research Andrew Jackson is quoted in the References.

A short video explains some of the key topics covered in this article:


Screen Shot 2014-03-12 at 15.26.55 Money creation in the modern economy (111KB)

A companion piece to this Bulletin article, ‘Money creation in the modern economy’, describes the process of money creation in more detail, and discusses the role of monetary policy and the central bank in that process. For expositional purposes this article concentrates on the United Kingdom, but the issues discussed are equally relevant to most economies today.

  • This article explains how the majority of money in the modern economy is created by commercial banks making loans.
  • Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits.
The article dispels a number of misconceptions about how Quantitative Easing works:
  • Just as in normal times, the reserves created by QE cannot be ‘multiplied up’ into additional loans and deposits. 
  • Nor can reserves be directly lent out, since only commercial banks hold reserves accounts.

 “Loans create deposits not the other way round.” 

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  • Andrew Cichocki

    This is so great! Thank you Positive Money for your hard work which lead to this, and thank you to the Bank of England for being the first central bank (that I know of) to publish something like this.

  • Crispy

    You guys should really start contacting.. everyone. MPs, that journalist who wanted to make a documentary, newspapers, economists, etc. Now you have the proof.

    But one thing that is missing from all this is a estimation of what all this amounts to – how much real wealth transfer from the public to banks/bankers does this system facilitate? Someone needs to do a calculation. A job for the professional economists, I think.

    If you don’t do this, then a lot of people’s reaction will just be ‘oh.. it works like that? So what?’

    • Peter Verity

      Crispy – this report goes some way to answering that question.

      • Crispy

        Thanks. I scanned through that doc, they seem to be saying the chief problem is that people borrow, buy assets, asset prices rise, people borrow more in order to get in on the rising asset prices, and so forth. This seems to me to be a bubble, which could occur with any financial system, could it not?

  • John Pablo

    Banking the rotten heart of capitalism?

  • Peter Verity

    7/10 for effort, but there is a glaring error in the diagram on p5 of ‘money in the modern economy’. It shows commercial bank liabilities exactly match reserves/currency only. In other words, full reserve banking!

    No mention of the private debt that forms a major part of commercial banks’ assets, and which back most of their liabilities.

    • Vince Richardson

      Yes it is misleading.It should say assets not reserves,that is naughty.And the banks make their own value up for that figure anyway by fiddling with their asset valuations… it is all still being brushed under the carpet in typically dry fashion.

  • Vince Richardson

    Well they could hardly deny this ,but it is gratifying to see them being so forthright about it.The videos do sound like they were made by Positive Money though.

    Liked the end bit of second video where it explained that QE could actually reduce the money supply if businesses use new shareholder money to pay off debt.QE is not a final solution at all.
    I see the Chancellor is about to help small house builders by getting banks to lend to them,a more direct way to inject money into the veins of our money supply,but at only £500 million it will not be enough.

  • halibr

    please join this conversation to the one about Austerity as a cure – the constant and unrelenting spin that “to reduce the deficit, we must make cuts” (always to vital infrastructure, never with a raise taxes or how to end bank bailouts.

  • flyingfish

    Could there still be things in these Bank of England documents that are off the mark?
    For example, “the ultimate determinant of monetary conditions in the economy is the monetary policy of the central bank.” (‘Money creation in the modern economy’, p.7). Is this really true? Also, the statement, “The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’,” (ibid., p.1) is potentially misleading to the degree that QE doesn’t increase the amount of money circulating in the productive economy.

    • Crispy

      How so? It adds to deposit accounts of the sellers of the bonds as well as to bank reserves. The thing I’m not sure about QE is what the effect of adding to those reserves is. Does this let banks lend more or not?

      • gaviscon_3

        In theory it should do. However because banks make their own decisions on who they lend to and what they spend the money on, we have today’s situation where QE has expanded the money supply but the man on the street is not benefitting. Two main reasons for this: 1) Up until recently society has been massively deleveraging since the crisis so a lot of QE money has simply replaced money destroyed by debt being payed off; and 2) banks have taken the QE deposits and used it for speculation and mortgage loans which keeps the money in the financial and housing markets. Inflation in these two markets is massively evident. The price of every financial asset (stocks, bonds, commodities, property etc) has been inflated by QE. For example when someone sells a house they are likely to spend the proceeds on another property. Main street does not see a penny.

        • Crispy

          “banks have taken the QE deposits and used it for speculation and mortgage loans”

          How do you mean? Are you talking about reserves or bank deposits? If bank deposits how do they take that money and do anything with it, it’s not theirs?

          I’m guessing the people who sold assets to the BoE have been causing the issues you talk about. Sell assets, buy other assets, up go the prices.

          • gaviscon_3

            Bank reserves

  • Simon Thorpe

    I was so disappointed when, following the Positive Money conference two weeks ago, there was nothing in the media about the fantastic work that PM has been doing. Over 400 participants, with more than 40 from outside the UK – and a total media blackout. But here is the proof that all that work has been worthwhile. Well done PM!!

  • SussexBySea

    All money is fiat. Even money ‘backed by gold. At some point, under a gold-backed money system, some one (the government) has to stipulate ***by fiat*** how much gold will back each unit of currency.

    There is no such thing as non-fiat money. Never has and never will be.

  • Simon Thorpe

    These latest documents and videos from the Bank of England are clearly a major step forward. But I agree that the suggestion that the Central Bank’s monetary policy is “the ultimate constraint on money creation” just isn’t convincing. While base money provided by the Central Bank may be useful for the banking sector, I really can’t see where there is any way that varying the interest rate can be used to limit anything in any real sense. Once you have abandoned the myth of the multiplier model (which McLeay, Radia and Thomas have done), how are we supposed to believe them when they claim that the Bank of England is in control of the money supply? It looks to me as though the commercial banks pretty much do precisely what they want. They create new money if they think that they have a good chance of earning money from the interest payments – and that’s about it.

  • Dr.S.G.Subbuswamy

    This article is spine chilling.
    It states that there are 3 factors limiting the power of Banks :
    i.because banks have to be able to lend profitably in a competitive market : But they don’t. If they fail, they are bailed out by tax-payers.

    ii.banks have to take steps to mitigate the risks associated with making additional loans. – The basis of the whole crisis is their inability to assess risks.
    iii.Monetary policy — the ultimate constraint on money creation – Monetary poilcy at present appears to be designed to allow banks to do exactly what they want.

    Do we laugh or cry at the idea that when we repay our debts, we are destroying money ?

    Unfortunately we cannot all repay all our debts and destroy the entire monetary system, but we must try and get some sense into it and out of it.

  • Marco Saba

    The fair value of the newly created credit is withheld from the financial statements of the banks.

  • Tertius Wehmeyer

    In May 1913 A Mitchell-Innes published the articles linked below in The Banking Law Journal.

    This clearly explains what the fractional reserve system is. Banks create universally legal IOUs or credit notes. A British IOU can be used in the USA today subject to foreign exchange.
    The real problem with this system is that banks raise interest on these IOUs. This interest will go into their own reserves as well as whatever banking costs are related to these transactions. This is how banks do business and make profit. And the central bank creates interest on their IOUs to the commercial banks. If the central bank is really a government entity, then this is an undeclared tax on the population as the interest will accumulate in the government’s bank. If the central bank is privately owned like the USA’s Federal Reserve, then it is a tax on the general population by the private owners of the central bank. A fractional reserve bank loan provides legal tender to the borrower who pays e.g. for a house. The seller can then use that money and the IOU is paid back when the borrower has paid of the principal. The interest should go to the seller as it is in reality not a cash sale or a direct exchange. However, the interest goes into the banking systems pockets who created the loan out of thin air (banking system = central bank + commercial banks)

    If commercial banks are constrained by the IOUs they can get from the central bank, i.e. they can only make loans up to the loans they have with the central bank, then the portion of interest which is the difference between their lending rate and that of the central bank, is what will be added to their own reserves in addition to their banking fees.

    In reality, banks can be replaced by accountants. And the banking system can be replaced by an accounting system. In our modern era, where Information and Communication Technologies are the basis of our record keeping and communication activities, a large portion of what the accountants do, can be done by ICT systems, so not so many accountants will be needed. The only human service banks really provide is the creation and maintenance of ICT systems, the intellectual know-how and to qualify the credit-worthiness of the borrower. Do we really need them?

    Lastly, in my opinion it is not a final solution that the government creates money as if a fully government owned central bank exists in a country, they are already doing it. A government should only issue IOUs annually on what they need for the annual aggregrate (national, provincial & municipal) government budget which should not exceed the annual aggregrate tax income. In the representative democracy that exists in most democratic countries in the world, the elected representatives are really like benevolent dictators. Very much like authoritarian parents who do the best for their children, even asks them what they want but rarely listens to the children (the electorate). Except for their favourites who help them to increase their assets.

    To really solve the financial problems that plague mankind we need a financial system based on sound, moral and fair accounting principles as well as a POLITICAL system based on Direct Democracy! The financial system can never be divorced from the political system. The representative democracies are manipulated by the moneyed elite in their own best interest, not that of the whole country. They do this through lobbying, bribes, ownership of the media, funding political parties etc. Money reform cannot happen without political reform as the financial reforms will soon be eroded by political influence on the representatives.

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