View source for Finance:Money creation

{{Short description|Process by which the money supply of an economic region is increased}}
{{Banking|terms}}
{{Macroeconomics sidebar}}
'''Money creation''', or '''money issuance''', is the process by which the [[Finance:Money supply|money supply]] of a country, or of an economic or monetary region,<ref group=note>Such as the Eurozone or [[Organization:Economic Community of Central African States|ECCAS]]</ref> is increased. In most modern economies, money is created by both [[Finance:Central bank|central bank]]s and [[Finance:Commercial bank|commercial bank]]s. Money issued by central banks is termed reserve deposits and is only available for use by central bank accounts holders, which is generally large commercial banks and foreign central banks. Central banks can increase the quantity of reserve deposits directly, by engaging in open market operations or [[Finance:Quantitative easing|quantitative easing]]. However, the majority of the money supply used by the public for conducting transactions is created by the commercial banking system in the form of bank deposits. Bank loans issued by commercial banks expands the quantity of bank deposits.<ref>{{cite web |last1=Bell |first1=Stephanie |title=https://www.researchgate.net/profile/Stephanie-Bell-3/publication/5208277_The_Role_of_the_State_and_the_Hierarchy_of_Money/links/5895102892851c8bb672d5f2/The-Role-of-the-State-and-the-Hierarchy-of-Money.pdf |url=https://www.researchgate.net/profile/Stephanie-Bell-3/publication/5208277_The_Role_of_the_State_and_the_Hierarchy_of_Money/links/5895102892851c8bb672d5f2/The-Role-of-the-State-and-the-Hierarchy-of-Money.pdf |website=Research Gate |publisher=Cambridge Journal of Economics |access-date=29 December 2023}}</ref>

Money creation occurs when the amount of loans issued by banks increases relative to the repayment and default of existing loans. Governmental authorities, including central banks and other bank regulators, can use various policies, mainly setting short-term [[Finance:Interest rate|interest rate]]s, to influence the amount of bank deposits created by commercial banks.<ref name="ecb2017">{{Cite web|url=https://www.ecb.europa.eu/explainers/tell-me-more/html/what_is_money.en.html|title=What is money?|last=European Central Bank|date=20 June 2017|website=European Central Bank|language=en|access-date=8 March 2018}}</ref>

==Money supply==
{{Main|Finance:Money supply}}
The term "money supply" commonly denotes the total, safe, financial assets that households and businesses can use to make payments or to hold as short-term investment.<ref name=fedms>[https://www.federalreserve.gov/faqs/money_12845.htm Money supply], [[Finance:Federal Reserve System|FRS]]</ref> The money supply is measured using the so-called "monetary aggregates", defined in accordance to their respective level of [[Finance:Liquidity|liquidity]]. In the United States, for example:

* '''M0''': The total of all physical currency including coinage. Using the United States dollar as an example, M0 = Federal Reserve notes + US notes + coins. It is not relevant whether the currency is held inside or outside of the private banking system as reserves.
* '''M1''': The total amount of M0 (cash/coin) outside of the private banking system{{Clarify|reason=Is this M0 different from the M0 number above? Sounds like M0 above includes reserve balances, M0 here does not?|date=December 2020}} plus the amount of [[Finance:Demand deposit|demand deposit]]s, [[Finance:Traveler's cheque|travelers checks]] and other checkable deposits
* '''M2''': M1 + most [[Finance:Savings account|savings account]]s, [[Finance:Money market account|money market account]]s, retail money market mutual funds, and small denomination time deposits ([[Finance:Certificate of deposit|certificates of deposit]] of under $100,000).

The money supply is understood to increase through activities by government authorities,<ref group=note>"A [state budget] deficit will lead to a direct rise in the money supply if the...Treasury finances the deficit not by borrowing but by drawing down balances it holds at commercial banks or [the central bank]." From Cacy (1975)</ref> by the central bank of the nation,<ref group=note>See "[[Finance:Money multiplier|Money multiplier]]"</ref> and by commercial banks.<ref name="ecb2018">{{cite web |url= https://www.ecb.europa.eu/press/key/date/2017/html/ecb.sp170516.en.html|title= Dissecting the yield curve: a central bank perspective|last= Cœuré|first= Benoît|date= 16 May 2017|website= Eurosystem|publisher= European Central Bank|access-date=8 March 2018 }}</ref>

==Money creation by the central bank==
===Central banks===

The authority through which monetary policy is conducted is the [[Finance:Central bank|central bank]] of the nation. The official goals of a central bank may vary, according to the country or the region. In most developed countries, central banks conduct their monetary policy within an [[Finance:Inflation targeting|inflation targeting]] framework,<ref>{{cite web |url=http://www.imf.org/external/pubs/ft/fandd/basics/target.htm |title=Inflation Targeting: Holding the Line |last=Jahan |first=Sarwat |publisher=International Monetary Funds, Finance & Development |access-date=17 October 2023}}</ref> whereas the monetary policies of most developing countries' central banks target some kind of a [[Finance:Fixed exchange rate system|fixed exchange rate system]].<ref name=IMF>{{cite book |last1=Department |first1=International Monetary Fund Monetary and Capital Markets |title=Annual Report on Exchange Arrangements and Exchange Restrictions 2022 |date=26 July 2023 |publisher=International Monetary Fund |isbn=979-8-4002-3526-9 |url=https://www.elibrary.imf.org/display/book/9798400235269/9798400235269.xml?code=imf.org |access-date=17 October 2023 |language=en }}</ref>

The central bank is the banker of the government<ref group=note>Formally, the Treasury's banker, or the banker of the respective competent authority, depending on the country, e.g. of the Ministry of Finance</ref> and provides to the government a range of services at the operational level, such as managing the Treasury's single account, and also acting as its fiscal agent (e.g. by running [[Finance:Auction|auction]]s), its settlement agent, and its bond registrar.<ref name="pessoa2012">{{cite web |url=https://www.imf.org/external/pubs/ft/tnm/2012/tnm1202.pdf|title= Government Cash Management: Relationship between the Treasury and the Central Bank|last1= Pessoa|first1= Mario|last2= Williams|first2= Mike|date= November 2012|website= Fiscal Affairs Dept|publisher= [[Organization:International Monetary Fund|International Monetary Fund]]|access-date=8 March 2018}}</ref> A central bank cannot become insolvent in its own currency. However, a central bank can become insolvent in liabilities on foreign currency.<ref name="buiter2008">{{cite journal |last1=Buiter |first1=Willem H. |title=Can Central Banks Go Broke? |journal=CEPR Policy Insight |date=May 2008 |volume=No. 24 |url=https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2489665 |access-date=17 October 2023}}</ref>

Central banks operate in practically every nation in the world, with few exceptions.<ref>List of central banks</ref> There are some groups of countries, for which, through agreement, a single entity acts as their central bank, such as the organization of states of Central Africa, <ref group=note>Established by Cameroon, Central African Republic, Chad, Republic of Congo, Equatorial Guinea and Gabon</ref> which all have a common central bank, the Bank of Central African States; or monetary unions, such as the Eurozone, whereby nations retain their respective central bank yet submit to the policies of the central entity, the European Central Bank. Central banking institutions are generally independent of the government [[Social:Executive (government)|executive]].<ref name="ecb2017" /> According to the Bank of England, more than 150 central banks were classed as independent in 2020.<ref>{{cite web |title=The insidious threats to central-bank independence |url=https://www.economist.com/finance-and-economics/2022/12/15/the-insidious-threats-to-central-bank-independence |website=The Economist |access-date=17 October 2023 |date=15 December 2020}}</ref>

===Monetary policy===
{{Main|Finance:Monetary policy}}
Monetary policy is the process by which the monetary authority of a country, typically the central bank (or the [[Finance:Currency board|currency board]]), manages the level of short-term [[Finance:Interest rate|interest rate]]s<ref group=note>It has been argued that the central bank of a fiscally and monetarily sovereign nation can actually affect, if not dictate, the whole interest spectrum – above which, of course, as it is argued, adjustments are made for their actual conduct of business by commercial banks and the private sector, in accordance to their assessments, objectives, and preferences. E.g.: "Monetary policy – and there we are increasingly certain – cannot only influence the expectations component, but also the term premium. ... Central banks can lower long-term rates by removing duration risk from the market." Cœuré (2017). Also:  "There is no evidence that the central bank has any meaningful control over the...spread between the short-term and the long-term rate of interest [but] it is quite clear that the central bank has full control over the long-term rate of interest.</ref><ref>{{cite web |url= https://fixingtheeconomists.wordpress.com/2014/08/15/does-the-central-banks-control-long-term-interest-rates-a-glance-at-operation-twist/|title= Does the Central Bank Control Long-Term Interest Rates?: A Glance at Operation Twist|last= Pilkington|first= Philip|date= 15 August 2014|website= Fixing the economists|access-date=8 March 2018 }}</ref> and influences the availability and the cost of credit in the economy,<ref name=fedmon>[https://www.federalreserve.gov/monetarypolicy.htm Monetary policy], FRS</ref> as well as overall economic activity.<ref name=imfmon>IMF (3 November 2017) "[http://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/20/Monetary-Policy-and-Central-Banking Monetary Policy and Central Banking]"</ref>

The central bank's activities directly affect interest rates, through controlling the preferred policy interest rate of the central bank (in the US this is the [[Finance:Federal funds rate|Federal funds rate]]). By affecting the level of interest rates, the central bank indirectly affects [[Finance:Investment|investment]], stock prices, [[Finance:Consumption (economics)|private consumption]] and the public's demand for money, as well as net export via the national currency's [[Finance:Exchange rate|exchange rate]]. The various channels through which [[Aggregate demand|aggregate demand]] is affected by changes in interest rates is known as the [[Finance:Monetary transmission mechanism|monetary transmission mechanism]].<ref name="Fed goals II">{{cite web |title=Federal Reserve Board - Monetary Policy: What Are Its Goals? How Does It Work? |url=https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm |website=Board of Governors of the Federal Reserve System |access-date=17 October 2023 |language=en |date=29 July 2021}}</ref>

[[Finance:Central bank|Central bank]]s usually conduct monetary policy either through administratively setting interest rates or through open market operations.<ref>{{cite web |last1=Baker |first1=Nick |last2=Rafter |first2=Sally |title=An International Perspective on Monetary Policy Implementation Systems {{!}} Bulletin – June 2022 |url=https://www.rba.gov.au/publications/bulletin/2022/jun/an-international-perspective-on-monetary-policy-implementation-systems.html |publisher=Reserve Bank of Australia |access-date=17 October 2023 |language=en-AU |date=16 June 2022}}</ref> Lowering interest rates or purchasing debt (resulting in an increase in bank reserves) is called monetary expansion or monetary easing, whereas the opposite is known as monetary contraction or tightening. An extraordinary process of monetary easing is denoted as [[Finance:Quantitative easing|quantitative easing]], whose intent is to stimulate the economy by increasing liquidity and promoting bank lending.

===Open-market operations===
Open-market operations (OMOs) concern the purchase and sale of securities in the open market by a central bank. OMOs essentially swap one type of financial assets for another; when the central bank buys bonds held by the banks or the private sector, bank reserves increase while bonds held by the banks or the public decrease. Temporary operations are typically used to address reserve needs that are deemed to be transitory in nature, while permanent operations accommodate the longer-term factors driving the expansion of the central bank's [[Finance:Balance sheet|balance sheet]]. Traditionally, such a primary factor has been the trend growth of currency (notes and coins) in circulation. Among the temporary, open-market operations are [[Finance:Repurchase agreement|repurchase agreement]]s (repos) or reverse repos, while permanent ones involve outright purchases or sales of securities.<ref name=omo>{{cite web |title=Open market operations |url=https://www.federalreserve.gov/monetarypolicy/bst_openmarketops.htm |website=www.federalreserve.gov |access-date=17 October 2023 |language=en |date=10 May 2021}}</ref> Each open-market operation by the central bank affects its balance sheet.<ref name=omo/>

===Physical currency===
The central bank, or other competent, state authorities (such as the treasury), are typically empowered to create new, physical currency, i.e. paper notes and coins, in order to meet the needs of commercial banks for cash withdrawals, and to replace worn and/or destroyed currency.<ref name=mankiw2012>Mankiw (2012)</ref>

In modern economies, relatively little of the supply of [[Finance:Broad money|broad money]] is in physical currency.<ref group=note>For example, in December 2010, in the United States, of the $8.853 trillion broad money supply (M2, table 1), only about 10% (or $915.7 billion, table 3) consisted of coins and paper money. See [http://www.federalreserve.gov/releases/h6/20110127/ Statistic], FRS</ref> In the United Kingdom, deposit money outweighs  the central bank issued currency by a factor of more than 30 to 1. In the United States, where the country's currency has a special international role being used in many transactions around the world, legally as well as illegally, the ratio is still more than 8 to 1.<ref name="Palgrave">{{cite book |last1=Friedman |first1=Benjamin M. |chapter=Money Supply |url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_875-2 |title=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan UK |pages=1–10 |language=en |doi=10.1057/978-1-349-95121-5_875-2 |date=2017|isbn=978-1-349-95121-5 }}</ref>

== Role of commercial banks ==
{{Main|Finance:Money multiplier}}
When commercial banks lend money, they expand the amount of bank deposits.<ref name=mcleay>{{cite web |url= https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf|title= Money creation in the modern economy|last1= McLeay|first1= Michael|last2= Radia |first2= Amar|last3= Thomas |first3= Ryland|date= 2014|website= Quarterly Bulletin|publisher= Bank of England|access-date=8 March 2018 }}</ref> 
The banking system can expand the money supply of a country beyond the amount created by the central bank, creating most of the [[Finance:Broad money|broad money]] in a process called the multiplier effect.<ref name=mcleay/>

Banks are limited in the total amount they can lend by their [[Finance:Capital adequacy ratio|capital adequacy ratio]]s and, in countries that impose required reserve ratios, also by these. Reserve requirements oblige commercial banks to keep a minimum, predetermined, percentage of their deposits at an account at the central bank. Many countries in the world, including the United States, Australia, Canada and New Zealand, do not impose minimum reserve requirements on banks. This does not allow commercial banks to lend without limit, however, since there is still, aside from other considerations, the [[Finance:Capital adequacy ratio|capital adequacy ratio]].

==Ultimate control of the money supply==

Whereas central banks can directly control the issuance of physical currency, the question to what extent they can control broad monetary aggregates like M2 by also indirectly controlling the money creation of commercial banks is more controversial.<ref name=Abel>{{cite journal |last1=Ábel |first1=István |last2=Lehmann |first2=Kristóf |last3=Tapaszti |first3=Attila |title=The controversial treatment of money and  banks in macroeconomics |journal=Financial and Economic Review |date=June 2016 |volume=15 |issue=2 |pages=33–58 |url=https://en-hitelintezetiszemle.mnb.hu/letoltes/istvan-abel-kristof-lehmann-attila-tapaszti-en.pdf |access-date=17 October 2023}}</ref> According to the [[Finance:Money multiplier|money multiplier]] theory, which is often cited in macroeconomics textbooks, the central bank controls the money multiplier because it can impose [[Finance:Reserve requirement|reserve requirement]]s, and consequently via this mechanism also governs the amount of money created by commercial banks.<ref name=Abel/><ref>{{cite web |last1=Ihrig |first1=Jane |last2=Weinbach |first2=Gretchen C. |last3=Wolla |first3=Scott A. |title=Teaching the Linkage Between Banks and the Fed: R.I.P. Money Multiplier |url=https://research.stlouisfed.org/publications/page1-econ/2021/09/17/teaching-the-linkage-between-banks-and-the-fed-r-i-p-money-multiplier |website=research.stlouisfed.org |access-date=18 October 2023 |language=en |date=September 2021}}</ref> Most central banks in developed countries, however, have ceased to rely on this theory and stopped shaping their monetary policy through required reserves.<ref name=Abel/> [[Biography:Benjamin M. Friedman|Benjamin Friedman]] explains in his chapter on the money supply in ''[[The New Palgrave Dictionary of Economics]]'' that the money multiplier representation is a short-hand simplification of a more complex equilibrium of supply and demand in the markets for both reserves ([[Finance:Outside money|outside money]]) and [[Finance:Inside money|inside money]]. Friedman adds that the simplification will work well or badly ''"depending on the strength of the relevant interest elasticities and the extent of variation in interest rates and the many other factors involved"''.<ref name="Palgrave"/> David Romer notes in his graduate textbook "''Advanced Macroeconomics''" that it is difficult for central banks to control broad monetary aggregates like M2.<ref>{{cite book |last1=Romer |first1=David |title=Advanced macroeconomics |date=2019 |publisher=McGraw-Hill |location=New York, NY |isbn=978-1-260-18521-8 |edition=Fifth |quote=The measures of the money stock that the central bank can control tightly, such as high-powered money, are not closely linked to [[Aggregate demand|aggregate demand]]. And the measures of the money stock that are sometimes closely linked with aggregate demand, such as ''M2'', are difficult for the central bank to control.}}</ref>{{rp|607–608}}

Monetarist theory, which was prominent during the 1970s and 1980s, argued that the central bank should concentrate on controlling the money supply through its monetary operations.<ref name="jahan2014">{{cite web |url=http://www.imf.org/external/pubs/ft/fandd/2014/03/pdf/basics.pdf|title=What Is Monetarism? |last1= Jahan|first1=Sarwat |last2= Papageorgiou|first2= Chris|date= March 2014|website= Finance & Development|publisher= IMF|access-date=8 March 2018 }}</ref> The strategy did not work well for the central banks like the Federal Reserve who tried it, however, and it was abandoned after some years, central banks turning to steer interest rates to obtain their monetary policy goals rather than holding the quantity of base money fixed in order to steer money growth.<ref name=Blanchard>{{cite book |last1=Blanchard |first1=Olivier |last2=Amighini |first2=Alessia |last3=Giavazzi |first3=Francesco |title=Macroeconomics: a European perspective |date=2017 |publisher=Pearson |isbn=978-1-292-08567-8 |edition=3rd}}</ref>{{rp|464–465}} Interest rates influence commercial bank issuance of credit indirectly, so the ceiling implied by the money multiplier does not impose a limit on money creation in practice.<ref>{{cite book |last1=Hubbard & O'Brien |title=Economics |chapter=Chapter 25, Monetary Policy |page=943}}</ref> By setting interest rates, central-bank operations will affect, but not control the money supply.<ref name="mcleay" /><ref group=note>"Another common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money. ... Rather than controlling the quantity of reserves, central banks today typically implement monetary policy by setting the price of reserves — that is, interest rates." McLeay (2014)</ref>

== Credit theory of money ==
{{Main|Finance:Credit theory of money}}

The [[Finance:Fractional-reserve banking|fractional reserve]] theory where the [[Finance:Money supply|money supply]] is limited by the [[Finance:Money multiplier|money multiplier]] has come under increased criticism since the [[Finance:Financial crisis of 2007–2008|financial crisis of 2007–2008]]. It has been observed that the [[Finance:Bank reserves|bank reserves]] are not a limiting factor because the [[Finance:Central bank|central bank]]s supply more reserves than necessary<ref name="SP2013">Standard & Poor's (13 August 2013) "[https://www.kreditmagazin.net/wp-content/uploads/2021/02/S_and_P__Repeat_After_Me_8_14_13.pdf Repeat after me: Banks cannot and do not lend out reserves]", Ratings Direct</ref> and because banks have been able to build up additional reserves when they were needed. Many economists and bankers now believe that the amount of money in circulation is limited only by the demand for loans, not by reserve requirements.<ref>{{cite journal |last1=Benes |first1=Jaromir |last2=Kumhof |first2=Michael |title=The Chicago Plan Revisited |journal=IMF Working Paper |date=2012 |volume=202 |url=https://www.imf.org/en/Publications/WP/Issues/2016/12/31/The-Chicago-Plan-Revisited-26178}}</ref><ref name="kumhof2016">{{cite journal |last1=Kumhof |first1=Michael |last2=Jakab |first2=Zoltán| title=The Truth about Banks |journal=Finance & Development |date=2016 |volume=53 |issue=1 |pages=50–53 |url=http://www.imf.org/external/pubs/ft/fandd/2016/03/kumhof.htm}}</ref><ref name="mcleay" />

The observation that there appears to be no limit to the amount of credit money that banks can bring into circulation in this way has given rise to the often-heard expression that "Banks are creating money out of thin air".<ref name="SP2013" /> The exact mechanism behind the creation of commercial bank money has been a controversial issue.

The [[Finance:Credit theory of money|credit theory of money]], initiated by [[Biography:Joseph Schumpeter|Joseph Schumpeter]], asserts the central role of banks as creators and allocators of the money supply, and distinguishes between "productive credit creation" (allowing non-inflationary [[Finance:Economic growth|economic growth]] even at [[Finance:Full employment|full employment]], in the presence of technological progress) and "unproductive credit creation" (resulting in [[Finance:Inflation|inflation]] of either the consumer- or [[Finance:Asset price inflation|asset-price]] variety).<ref>{{cite book |last= Schumpeter|first= Joseph A.|date= 1996|orig-year=1954|title= History of Economic Analysis|publisher= Oxford University Press|isbn= 978-0195105599|}}</ref>

The model of bank lending stimulated through central-bank operations (such as "monetary easing") has been rejected by [[Finance:Neo-Keynesian economics|Neo-Keynesian]]<ref group=note>"By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can encourage an increase in the supply of money and bank deposits. Without taking drastic action, they can encourage but they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves."</ref><ref>{{cite book|last= Samuelson|first= Paul|date= 1997|orig-year= 1948|title= Economics|url= https://archive.org/details/economicsintrodu0000samu|publisher= McGraw-Hill Education|isbn= 978-0070747418|url-access= registration}}</ref> and [[Finance:Post-Keynesian economics|Post-Keynesian]] analysis<ref name=kelton>{{cite web|last=Kelton, ''née'' Bell|first=Stephanie |url=https://ideas.repec.org/p/wpa/wuwpma/9805014.html |title=The Hierarchy of Money|date=1998  |publisher=The Jerome Levy Economics Institute|ssrn=96845}}</ref><ref name="mitch2009">{{cite web |url=http://bilbo.economicoutlook.net/blog/?p=1623|title= Money multiplier and other myths|last= Mitchell|first= William|author-link=Bill Mitchell (economist)|date= 21 April 2009|access-date=8 March 2018}}</ref> as well as central banks.<ref name="tucker2007">{{cite web |last=Tucker|first=Paul|url=https://www.bankofengland.co.uk/-/media/boe/files/speech/2007/money-and-credit-banking-and-the-macroeconomy.pdf|title=Money and credit: Banking and the Macroeconomy|date=2007 |publisher=Bank of England }}</ref><ref name=Disyatat>{{Cite web|url=http://www.bis.org/publ/work297.pdf|title=The bank lending channel revisited|last=Disyatat|first=Piti|date=February 2010|publisher=Bank of International Settlements|website=BIS Working Papers|language=en|access-date=8 March 2018}}</ref><ref group=note>"In reality, neither are [bank] reserves a binding constraint on lending, nor does the central bank fix the amount of reserves that are available. ... Banks first decide how much to lend depending on the profitable lending opportunities available to them — which will, crucially, depend on the interest rate set by the [central bank]." McLeay et al. (2014)</ref>
The major argument offered by dissident analysis is that any bank balance-sheet expansion (e.g. through a new loan) that leaves the bank short of the required reserves may affect the return it can expect on the loan, because of the extra cost the bank will undertake to return within the ratios limits – but this does not and  "will never impede the bank's capacity to give the loan in the first place". Banks first lend and ''then'' cover their reserve ratios: The decision whether or not to lend is generally independent of their reserves with the central bank or their deposits from customers; banks are not lending out deposits or reserves, anyway. Banks lend on the basis of lending criteria, such as the status of the customer's business, the loan's prospects, and/or the overall economic situation.<ref>{{Cite web |title=Money and Inflation|last=Wray|first=L. Randall|url=https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1010331|date=1 September 2000|publisher=University of Missouri-Kansas City|language=en|ssrn = 1010331}}</ref>

[[File:Credit_Mechanics_4_mechanical_interrelationships_governing_the_credit_volume_(Table_1_by_F._Decker_&_C._Goodhart_2021).PNG|200px|thumbnail|right|In accordance to "credit mechanics" bank money expansion or destruction (or not changing) depends on payment flows.]]
Bank of England tells us in 2019: "Most of the money in the economy is created by banks when they provide loans.",<ref>BoE (2019): [https://www.bankofengland.co.uk/explainers/how-is-money-created How is money created]</ref> but not every provided loan is heightening bank money amount. It depends on payment flows after given loans.<ref>Frank Decker, Charles A.E. Goodhart: ''Wilhelm Lautenbach’s credit mechanics – a precursor to the current money supply debate'', Taylor & Francis, 2021, DOI=10.1080/09672567.2021.1963796.</ref> (see table by Decker/Goodhart [2021] beside).

== Monetary financing ==
{{Main|Finance:Debt monetization}}

===Policy===
"Monetary financing", also "debt monetization", occurs when the country's central bank purchases government debt.<ref>{{cite book|last=Mishkin|first=Frederic S.|title=The economics of money, banking and financial markets|url=https://spu.fem.uniag.sk/Marian.Toth/finance/20142015/MBFM.pdf|location=Canada|publisher=Addison-Wesley|year=2011|orig-year=2002|edition=4th|isbn=978-0-321-58471-7|access-date=2018-03-11|archive-date=2018-03-10|archive-url=https://web.archive.org/web/20180310074333/https://spu.fem.uniag.sk/Marian.Toth/finance/20142015/MBFM.pdf|url-status=dead}}</ref> It is considered by mainstream analysis to cause [[Finance:Inflation|inflation]], and often [[Finance:Hyperinflation|hyperinflation]].<ref>{{Cite web|url=https://scholar.harvard.edu/files/mankiw/files/govdebt.pdf|title=The bank lending channel revisited|last1=Elmendorf|first1=Douglas W.|last2=Mankiw|first2=N. Gregory|author-link2=N. Gregory Mankiw|date=January 1998|publisher=[[Organization:Harvard University|Harvard University]]|website=Handbook of Macroeconomicss|language=en|access-date=8 March 2018}}</ref> IMF's former chief economist [[Biography:Olivier Blanchard|Olivier Blanchard]] states that: <blockquote>governments do not create money; the central bank does. But with the central bank's cooperation, the government can in effect finance itself by money creation. It can issue bonds and ask the central bank to buy them. The central bank then pays the government with money it creates, and the government in turn uses that money to finance the deficit. This process is called debt monetization.<ref>{{cite book |last1= Blanchard|first1= Olivier|author-link= Olivier Blanchard |last2=David R. Johnson |first2=David R. Johnson  |date= 2012|title=Macroeconomics |edition=6th|publisher=  Pearson|isbn= 978-0133061635}}</ref></blockquote> The description of the process differs in [[Finance:Heterodox economics|heterodox]] analysis. Modern [[Finance:Chartalism|chartalists]] state: <blockquote>the central bank does not have the option to monetize any of the outstanding government debt or newly issued government debt...[A]s long as the central bank has a mandate to maintain a short-term interest rate target, the size of its purchases and sales of government debt are not discretionary. The central bank's lack of control over the quantity of reserves underscores the impossibility of debt monetization. The central bank is unable to monetize the government debt by purchasing government securities at will because to do so would cause the short-term target rate to fall to zero or to any support rate that it might have in place for excess reserves.<ref name="mitchell2008">{{cite book |last1= Mitchell|first1= William|author-link= Bill Mitchell (economist) |last2=Muysken|first2=Joan |author-link2=Joan Muysken|date= 2008|title= Full Employment Abandoned: Shifting Sands and Policy Failures|publisher=  Edward Elgar Publishing|isbn= 978-1-85898-507-7}}</ref></blockquote>

===Restrictions===
Monetary financing used to be standard monetary policy in many countries, such as Canada or France,<ref name=ryan2015>{{Cite web|url=http://www.levyinstitute.org/publications/is-monetary-financing-inflationary-a-case-study-of-the-canadian-economy-1935-75|title=Is Monetary Financing Inflationary? A Case Study of the Canadian Economy, 1935–75|last=Ryan-Collins|first=Josh|date=25 October 2015|publisher= Levy Economics Institute|access-date=8 March 2018}}</ref> while in others it was and still is prohibited. In the Eurozone, Article 123 of the Lisbon Treaty explicitly prohibits the European Central Bank from financing public institutions and state governments.<ref>[https://www.ecb.europa.eu/mopo/eaec/fiscal/html/index.en.html Fiscal policies], ECB</ref> In Japan, the nation's central bank "routinely" purchases approximately 70% of state debt issued each month,<ref>{{cite web |url= http://www.businessinsider.com/japans-1-trillion-yen-of-debt-2013-8|title=Japan's Debt Has Officially Passed ¥1,000,000,000,000,000 — No Problem|last= Evans-Pritchard|first=  Ambrose|date= 10 August 2013|website= The Daily Telegraph|access-date=8 March 2018 }}</ref> and owns, as of Oct 2018, approximately 440 trillion JP¥ (approx. $4trillion)<ref group=note>At a $1=¥0.0094 conversion rate</ref> or over 40% of all outstanding government bonds.<ref>[https://www.boj.or.jp/en/statistics/boj/other/mei/index.htm/ Gov't Bonds], Bank of Japan</ref> In the United States, the 1913 [[Finance:Federal Reserve Act|Federal Reserve Act]] allowed [[Finance:Federal Reserve System|federal]] banks to purchase short-term securities directly from the Treasury, in order to facilitate its cash-management operations. The Banking Act of 1935 prohibited the central bank from directly purchasing Treasury securities, and permitted their purchase and sale only "in the open market". In 1942, during wartime, Congress amended the Banking Act's provisions to allow purchases of government debt by the federal banks, with the total amount they'd hold "not [to] exceed $5 billion". After the war, the exemption was renewed, with time limitations, until it was allowed to expire in June 1981.<ref name="garbade">{{cite web |last=Garbade |first=Kenneth D. | url=https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr684.pdf |title=Direct Purchases of U.S. Treasury Securities by Federal Reserve Banks |date=August 2014|website= FRBNY Staff Reports no. 684}}</ref>

==See also==
{{div col}}
* Commissary notes
* Commodity money
* [[Finance:Fiat money|Fiat money]]
* [[Finance:Fiscal policy|Fiscal policy]]
* [[Finance:Functional finance|Functional finance]]
* [[Chemistry:Gold standard|Gold standard]]
* [[Finance:History of banking|History of banking]]
* History of money
* [[Finance:Monetary economics|Monetary economics]]
* [[Finance:Monetary reform|Monetary reform]]
* [[Finance:Seigniorage|Seigniorage]]
{{div col end}}

==Footnotes==
{{Reflist|group=note|2}}

==References==
{{Reflist}}

==Further reading==
*{{cite web |url= https://www.imf.org/external/pubs/ft/fandd/2012/09/pdf/basics.pdf|title=What Is Money?|last1= Asmundson|first1= Irena |last2= Oner|first2= Ceyda|date= September 2012|website= Finance & Development|publisher= IMF|access-date=8 March 2018 }}
*[http://www.federalreserve.gov/releases/h6/hist/h6hist1.htm Federal Reserve historical statistics] (11 June 2009) {{webarchive |url=https://web.archive.org/web/20090605101615/http://www.federalreserve.gov/releases/h6/hist/h6hist1.htm |date=June 5, 2009 }}
*{{cite book |last= Hegeland|first= Hugo  |date= 1970|orig-year=1954 |edition=7|title= Multiplier Theory|publisher= Harvard University Press|isbn= 978-0678001622}}
*{{cite book|last=Mankiw |first=N. Gregory |title=Macroeconomics |publisher=Worth |year=2012 |edition=8th|isbn=978-1429240024 |pages=81–107}}

==External links==
*"[http://www.bis.org/publ/cpss55.pdf The Role of Central Bank Money in Payment Systems]", [[Organization:Bank for International Settlements|Bank for International Settlements]], August 2003
*[[Biography:Bill Mitchell (economist)|Mitchell, William]] (2009) "[http://bilbo.economicoutlook.net/blog/?p=332 Deficit spending 101: Part 1]"; "[http://bilbo.economicoutlook.net/blog/?p=352 Part 2]"; "[http://bilbo.economicoutlook.net/blog/?p=381 Part 3]"

{{Central banks}}
{{Economics}}

[[Category:Monetary policy]]
[[Category:Banking]]

{{Sourceattribution|Money creation}}