Where Does Money Come From?

By on March 20, 2014

It’s a big question and the Bank of England (BoE) has come up with an interesting and suitably big – 14 page – answer that we should all read.

Beyond knowing that your Mum was right and that sadly it doesn’t grow on trees, most of us have only a hazy idea of where money really comes from in the modern economy.

It’s one of those tail-chasing questions that can make your head hurt if you think about it too much – OK you get paid at the end of the month, but where did that money ultimately come from? How much money is there out there? And who controls the supply?

Back in the days of the Gold Standard and mainly cash transactions, it was relatively simple. You had as much money as you had gold in the vault. But in these days of electronic transfer, Fiat money, ultra-low interest rates and mind-bogglingly large government interventions aimed at boosting the money supply, things are a great deal more complicated.

Alarmed perhaps by the suggestion that it has more control over money supply than it actually does, the Bank of England has issued a magisterial document explaining not only where money comes from but also exactly how quantitative easing (QE) is supposed to work.

It’s 14 – rather nourishing – pages but probably the best explanation of 21st Century monetarism we have read. Our only criticism is that it’s about five years late, but never mind.

For those who can’t be bothered (sorry, don’t have the time) to tackle the whole thing, here are three top facts to help you feel smug:

1. Money is created every time a bank makes a loan to a customer – This debunks the classical view that banks only lend money that is already in circulation.

2. QE is not supposed to be about giving more money to banks – Rather it is institutional investors like pension funds who are supposed to benefit first, then the rest of us by trickle down. (MT wonders if this isn’t partly wishful thinking).

3. There is no ‘money multiplier’ effect on bank lending – Lending in the economy is not controlled directly by the BoE through the amount of central bank money it makes available.

For the report, in all its glory – click here.

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