Nib asked
How do central banks create money?
Central banks create reserves and cash, but most of the money you use is made by ordinary banks every time they lend; the central bank steers it by the price of borrowing.
7 steps, drawn by Nib. Read it here, or watch him draw it. Updated .
1the myth
Picture a central bank as a giant printing press. Not really! In Britain, about ninety-seven percent of the money people hold is bank deposits, and only about three percent is cash.
Most money is bank deposits, not printed cash.
a common mix-upCentral banks print most of the money.
2who makes it
So who makes the other ninety-seven percent? Ordinary banks do, every time they make a loan. The central bank mostly sets the stage, and steers the price of borrowing.
3reserves
What a central bank itself creates is called reserves. It buys a bond from a bank and pays by typing new digits into that bank's account at the central bank.
The central bank creates reserves by crediting bank accounts.
4at scale
Do that on a huge scale and it is called quantitative easing. The Federal Reserve's balance sheet grew from under one trillion dollars in 2008 to about nine trillion in 2022.
5a loan
Here is the creation most of us use. You borrow ten thousand dollars. The bank writes the loan as its asset, and at the same moment writes a new deposit for you as its liability.
A loan creates a matching deposit at the same moment.
6the brake
What holds banks back? Borrowers who can repay, capital rules, and the interest rate. The central bank sets its policy rate, and that feeds through to loans, and so to deposits.
7the whole idea
So the whole picture: the central bank creates the base, reserves and cash. Banks create most of the money by lending. And the central bank steers by the price of loans.
Next time you hear that money is printed, remember: a few keystrokes at a bank do most of the creating.