Who creates money?

Money creation starts much the way you would expect. A government agency like a central bank or a treasury puts in an order for more money to be printed. Then, in a factory or mint somewhere, someone’s face is stamped on a bill or coin, turning previously useless paper or metal into valuable currency. This money is then shipped to private commercial banks, who give it to the the rest of us when we make a withdrawal from our bank or ATM.

But that’s only a small part of the story. Roughly 3 percent of the story to be exact.¹

Banks hold your cash for you, in the form of deposits. But they don’t just keep all the money in a vault. They give it out to other people in the form of loans. This means that at any given time, only a small fraction of your money is actually sitting in a bank vault. Economists call this fractional reserve banking. And it’s quite important because it means the rest of your money has been lent out to someone else and is now floating around the economy, buying pizzas or paying employees.

This is the slightly mind-boggling part: because you have your money as a deposit at the bank, and someone else also has your money as a loan from the bank, your money has effectively doubled by nature of being in the bank, and not under your mattress, increasing the total money supply in the economy. The chain doesn’t stop there though. Whoever took a loan from the bank will either spend the money or keep it in their own account at the bank. Either way, as soon as the money gets back to a bank as a deposit, it can be lent back out again and doubled.

Banks do keep some of your original money in the vault—either to limit risks or because the government makes them—so the system can’t go on forever. But the process is still powerful enough to create the vast majority of the money in the economy. In the UK, 97 percent of the money is created like this, with only about 3 percent printed as physical notes and coins.¹ Other countries have similar ratios.

So, who creates money? You do! By putting money in the bank, or taking a loan, you’re helping create money. Your bank is also involved; they get to decide whether to make new loans or not. And so is your government, which regulates the whole system.

Is this a good way to create money? As you might expect, that’s a pretty controversial question.