How is money created?

📘 Briefly explained

Money today is created predominantly through lending by commercial banks. When a bank grants a customer a loan, it simply credits the amount to their account without corresponding deposits having to exist beforehand. This creates new book money, which becomes part of the money supply as a demand deposit. The bank merely has to comply with certain capital and liquidity requirements, but does not have to cover every loan with existing central bank money. Central banks, by contrast, create only so-called base money in the form of cash and reserves, which commercial banks use among themselves and for withdrawals. Overall, money is therefore created primarily through lending by commercial banks and not through savings deposits or government minting alone.

🔍 Why this matters

Money today is created predominantly through lending by commercial banks to private households, businesses, and the government. When a bank grants a loan, it credits the borrower with a corresponding amount in their account, thereby creating new book money. This book money is legally a claim by the customer against the bank and is accepted in everyday life as a means of payment. Central banks, by contrast, create only central bank money, which commercial banks need for payments among themselves and for reserve requirements. The amount of money in circulation is therefore determined to a significant extent by the demand for credit and the lending policies of banks. Government regulation and central bank monetary policy influence this process by setting interest rates, capital requirements, and refinancing conditions.

📈 Key points

Money today is created predominantly through lending by commercial banks, not through physical production or government minting. When a bank grants a customer a loan, it credits the amount to their account as a balance, thereby creating new book money. This book money is the basis of most payments in modern economies. Central banks, by contrast, create only central bank money, which commercial banks use among themselves and for exchange into cash. The money supply therefore grows primarily when banks grant loans and shrinks when loans are repaid. What is crucial here is that lending is tied to demand, collateral, and interest rate expectations.

🧠 What investors should pay attention to

Money today is created predominantly through lending by commercial banks to customers or other banks. When a bank grants a loan, it credits the borrower with the amount in their account without corresponding deposits having to exist beforehand. This creates new book money, which is covered only by the bank’s willingness to accept this money again later as a means of payment. The central bank influences this process by providing reserves to banks and setting the key interest rate. In practice, this means that the money supply depends heavily on the demand for credit and the lending policies of banks. Anyone who wants to understand how money is created should therefore not look only at bills and coins, but above all at the accounting of loans and deposits.

📝 Conclusion

Money today is created predominantly through lending by commercial banks. When a bank grants a customer a loan, it credits the amount to their account without corresponding deposits having to exist beforehand. This creates new book money, which becomes part of the money supply as a demand deposit. The bank merely has to comply with certain capital and liquidity requirements, but does not have to cover every loan with existing central bank money. Central banks additionally create cash and influence banks‘ lending through the key interest rate as well as bond purchases. Overall, money is therefore not a scarce resource that exists independently, but arises endogenously from the interplay of credit demand, bank decisions, and monetary policy framework conditions.