How Money Is Created

How Money is Created

Money is created in two ways. First money comes from borrowing it and spending it. “Most of the total money supply is created by banks making loans to the non-bank public”. (Smithy, 2008) Second, it can come by being printed up “out of thin air” by a central bank (the Federal Reserve in the United States). Central banks have two major powers: “they can regulate the nominal level of short-term interest rates, and they can purchase assets such as government debt, with newly printed money”. (Benson, 2004) When the central bank lowers the rate of short-term interest, it greatly encourages corporate and individual borrowing and spending. Base money is created when the Federal Reserve performs what are known as Open Market Operations. Here, the Federal Reserve injects money by buying Government Securities, or also known as , creating money “out of thin air”, which then becomes owned by the government (the American Taxpayer) to the Federal Reserve. “The Federal Reserve has no budget, quite simply because it doesn’t need one- it invents money whenever it needs it.” (Smithy, 2008) The Federal Reserve creates a liability on its balance sheet, which the public must repay through the efforts of real work. Once the base money is created, banks can create around 10 times this amount in checking accounts and other deposits. They do this by making loans to the public. “This means when you go to borrow money to buy a house or car, the money is really being created “out of thin air” by the bank, and being credited to the checking account of the seller.” (Smithy, 2008)

The net borrowing in the United States is quite impressive, “in 2003, the savings rate was 2% of the GDP, while the net credit market borrowing had and excess of 20% of GDP.”