How is money created in the UK? <\/p>\n\n\n\n
Most people will never have given this a moment’s thought, and would have no idea how to answer. If pushed though, I’d bet a common answer would be “by the Bank of England”.<\/p>\n\n\n\n
That seems a sensible answer \u2013 but it’s mostly wrong. The Bank of England does create some<\/em> money, but the vast majority is brought into existence by your average high street bank. <\/p>\n\n\n\n You may even have seen it happen in front of you, but not realised. In this article, I’ll explain how they do it.<\/p>\n\n\n\n You might have the idea that banks take in deposits from one group of people, then lend them out to another group of people. They pay you interest at 1%, lend it out at 4%, and keep a 3% spread for themselves as profit. This was the case once, but it\u2019s not any more.<\/p>\n\n\n\n If you\u2019ve studied some economics, you might believe that banks engage in \u201cfractional reserve\u201d lending \u2013 meaning that for every \u00a31 deposited by savers, they can lend out (say) \u00a39. This was also once true, but isn\u2019t now.<\/p>\n\n\n\n In reality, the lending done by banks has very little to do with money deposited by savers<\/strong>. They don\u2019t need your savings in order to make a loan \u2013 because money is created purely by the act of making a loan itself<\/em>.<\/p>\n\n\n\n This sounds crazy, and doesn\u2019t accord with our intuitive understanding of how lending works. If I borrow \u00a3100 from you, you have \u00a3100 less and I have \u00a3100 more. Money has moved<\/em>, not been created. But banks are special<\/strong>: they almost literally have a license to print money. Let\u2019s see how it works.<\/p>\n\n\n\n Adam walks into the bank wanting a \u00a3200,000 loan to start a business. The bank makes some checks to assess his ability to pay the loan back as promised. It does not<\/em> check to make sure that it has \u00a3200,000 deposited by savers to pass on to Adam. It doesn’t matter if they do or don’t.<\/p>\n\n\n\n If the bank decides Adam is a good risk for the loan, a bank employee will open an account for him and type the number \u201c2\u201d followed by five zeroes. <\/p>\n\n\n\n That. Is. It. <\/p>\n\n\n\n The \u00a3200,000 has literally been typed into existence, and Adam can go buy the equipment he needs to start his business. As a result of this loan, there’s \u00a3200,000 more money in circulation in the UK<\/strong>.<\/p>\n\n\n\n In accounting terms, where everything needs to balance, the bank now has a new liability<\/em> (the \u00a3200,000 they gave Adam) and also a new asset<\/em> (his promise to repay \u00a3200,000). These entries were both created by the act of making the loan itself: the money wasn\u2019t brought over from anywhere else.<\/p>\n\n\n\n (This is why accounting seems weird to non-accountants: if someone owed you money, you probably wouldn’t consider that to be an asset of yours. You’d be more likely to worry about them not<\/em> paying it to you, and only consider it an asset once it’s safely in your possession. But that’s not how accounting works.)<\/p>\n\n\n\n When Adam repays the loan, the opposite happens: the money ceases to exist<\/em>. The loan account that had \u00a3200,000 typed into it is replaced by \u00a30, and the bank\u2019s asset and liability go away. Sure, Adam’s business must have earned money from other people to generate that \u00a3200,000, so money has been changing hands \u2013 but the overall quantity<\/em> of money shrinks when the loan is repaid.<\/p>\n\n\n\n At first it takes a bit of getting your head around the fact that creating money is as simple as typing it in. It doesn\u2019t feel \u201cright\u201d: surely some people borrowing requires others to be saving? Nope. <\/p>\n\n\n\n It might take you a few read-throughs of the previous section, and scribbling some numbers on a piece of paper to follow along, before it makes sense. That might be because my explanation isn’t very good, but it’s certainly not because there’s anything wrong with you: it just “feels wrong”, and your intuition and past education both lead you astray.<\/p>\n\n\n\n In fact, GK Galbraith rather neatly put it like this:<\/p>\n\n\n\n \u201cThe process by which banks create money is so simple that the mind is repelled. When something so important is involved, a deeper mystery seems only decent.\u201d<\/p>GK Galbraith<\/cite><\/blockquote><\/figure>\n\n\n\n As we’ve seen, the money was magicked into existence by making the loan, so the bank doesn\u2019t need to have a certain \u201cstock\u201d of money to lend out. Given that the bank earns fees and interest every time they make a loan, the temptation must be to give loans to anyone who comes through the door.<\/p>\n\n\n\n What prevents them from doing this? <\/p>\n\n\n\n There are a few reasons:<\/p>\n\n\n\n So even though banks create money by just doing the banking equivalent of waving a magic wand, there are still practical limits on how much money they can create. And even though banks are in the driving seat when it comes to money creation, our side-points show that both the government and the Bank of England can sit in the passenger seat shouting at them to ignore the sat-nav and go their preferred way instead.<\/p>\n","protected":false},"excerpt":{"rendered":" Money in the UK isn’t created how you expect, or by whom you expect. The real answer is so simple it might take some getting to grips with…<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[12],"tags":[],"yoast_head":"\nSpoiler: It’s nothing to do with savers<\/h2>\n\n\n\n
Money-creation in action<\/h2>\n\n\n\n
Too simple to understand<\/h2>\n\n\n\n
So is money creation limitless?<\/h2>\n\n\n\n
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(Interesting side-point #1: This means that “government backed” loans, like the “Bounce Back” and various other Covid-related loans introduced in 2020, increase<\/em> money creation: banks will make more loans to more dubious customers than they otherwise would have done, because their losses will be made good by the government.)
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(Interesting side-point #2: This means that even though the vast majority of money-creation in the UK is performed by private banks, the Bank of England still indirectly controls how much<\/em> money is created.)<\/li><\/ol>\n\n\n\n