Money in the modern economy: an introduction
This article 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.
Money creation in the modern economy
‘Money in the modern economy: an introduction’, a companion piece to this article, provides an overview of what is meant by money and the different types of money that exist in a modern economy, briefly touching upon how each type of money is created. This article explores money creation in the modern economy in more detail. The article begins by outlining two common misconceptions about money creation, and explaining how, in the modern economy, money is largely created by commercial banks making loans.
Can banks individually create money out of nothing? — The theories and the empirical evidence
This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction.
MODERN MONEY MECHANICS
The purpose of this booklet is to describe the basic process of money creation in a “fractional reserve” banking system. The approach taken illustrates the changes in bank balance sheets that occur when deposits in banks change as a result of monetary action by the Federal Reserve System – the central bank of the United States. The relationships shown are based on simplifying assumptions. For the sake of simplicity, the relationships are shown as if they were mechanical, but they are not, as is described later in the booklet. Thus, they should not be interpreted to imply a close and predictable relationship between a specific central bank transaction and the quantity of money.