Time to rewrite the textbooks on money creation

12 March, 2014 at 19:13 | Posted in Economics | 6 Comments

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This article has discussed how money is created in the modern economy. Most of the money in circulation is created, not by the printing presses of the Bank of England, but by the commercial banks themselves: banks create money whenever they lend to someone in the economy or buy an asset from consumers. And in contrast to descriptions found in some textbooks, the Bank of England does not directly control the quantity of either base or broad money. The Bank of England is nevertheless still able to influence the amount of money in the economy. It does so in normal times by setting monetary policy — through the interest rate that it pays on reserves held by commercial banks with the Bank of England. More recently, though, with Bank Rate constrained by the effective lower bound, the Bank of England’s asset purchase programme has sought to raise the quantity of broad money in circulation. This in turn affects the prices and quantities of a range of assets in the economy, including money.

Michael McLeay, Amar Radia and Ryland Thomas of Bank of England’s Monetary Analysis Directorate

(h/t Phil Pilkington)

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6 Comments »

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  1. There is a tremendous amount of confusion about the printing of money. I hope you can clear up the misconceptions.

  2. Very good, begining with Benjamin Franklin.

  3. Strikes me the textbooks are right. As the BoE article itself says, and in reference to a bank making a loan, that will lead “..other things equal, to increased inflationary pressure..”. And that in turn means the central bank has to raise interest rates, which will cut lending. Ergo, if the economy is at capacity, a bank cannot make a loan worth $X unless someone saves $X. Thus the textbooks are right.

    I’ve expanded on that point here:

    http://ralphanomics.blogspot.co.uk/2014/03/when-bank-makes-loan-does-it-create.html

  4. There is real money and credit money. For some periods of time they may be indistinguishable. But during other periods of time, real money talks, and credit money “walks”. Eventually, when a loan is repaid the money is out of the system and what is left is maybe the wealth they have created, if any at all.


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