Time to rewrite textbooks on money creation

20 Apr, 2019 at 10:30 | Posted in Economics | 2 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.

M. McLeay, A. Radia & R. Thomas
Bank of England’s Monetary Analysis Directorate

 

2 Comments

  1. What does your MP know about money? My answer is “considerably less than the average chimpanzee”….:-)

  2. A glance at a graphical depiction of the Fed’s balance sheet ( http://subbot.org/misc/econ/fed_balance_sheet.jpg ) reveals that the decision to “destroy money” upon loan repayment is entirely up to the discretion of the bank. Rather than destroy money created and repaid, the bank can easily reinvest the repaid, created money in other loans, just as the Fed reinvested proceeds of its Mortgage-backed securities in purchases of other MBS for years. Currently, the Fed is likely to stop destroying money and start reinvesting again.
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    The account of private money creation above also is deficient, in that it leaves out interest. Interest often amounts to more than the created loan money, and is not destroyed but put into Net Worth.
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    The Fed’s balance sheet is also interesting because as Reserves shrink, banks are replacing them with Treasuries. However, the destroyed reserves should come from banks repaying MBS to the Fed. Where are banks getting the money to b=replace their reserves with Treasuries? The banks must be paying for Treasuries with more bank money. Thus does private bank-created money turn into something you can swap for a risk-free highly liquid Level I Treasury asset.
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    The point: new bank-created money is rarely destroyed. Banks have ways of keeping their credit issues circulating as money indefinitely, as implied future claims on the Fed.


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