Who REALLY creates ‘money’ in the UK economy?

Classically, ‘money’ has been strongly equated to currency, which was represented by physical notes and coins. However, as technology has advanced, the identity of money has adapted and evolved from this relatively simple conceptualization. The definition of ‘money’ I will be working from is that “anything widely accepted as payment, particularly by the government as payment of tax, is, to all intents and purpose, money.” (Josh Ryan-Collins, 2011, p. 1) This particular definition we derive the argument from is key to the conclusion we formulate as the definition widens the realm from that of strictly cash money or base money, to include also broad or credit money and as we will uncover it is this secondary form of ‘money’ which now dominates the sphere.

The classical view – the Bank of England:

This section begins by uncovering the myth between who ought to be creating money in the economy before latterly continuing the quest to discover who really is. This section concentrates on the orthodox view of money creation with the pivotal role belonging to the Bank of England where “the central bank is responsible for controlling the supply of money in the economy.” (Gregory Mankiw, 2014, p. 571)

The main aim of the Bank of England is to “reach (their) inflation target of 2%.” (BofE, 2017) Therefore, controlling the total supply of money and ultimately controlling the total amount of spending within the economy is vital in achieving this. This total control over inflation requires sole control over the money supply in order for monetary policy to be completely effective. However, as I will go on to explore, due to the expanding money supply, in reality in the UK “monetary policy is of very limited effectiveness… in constraining inflation.” (Minsky, 1957, p. 184)

The central banks key tool for combatting inflationary pressures, and main way of creating new money in the economy, is Quantitative Easing. “QE is intended to boost the amount of money in the economy directly by purchasing assets, mainly from non-bank financial companies.”  (Michael McLeay, 2014, p. 14) Of course the reverse is equally true did the Bank of England need to ‘cool’ spending in the economy. The central bank digitally creates currency, with which it purchases government bonds from the private sphere of the economy with compulsory buy-back agreements and thus this introduces new money into the economy, equally when the Bank of England sell the bonds back to the public they are destroying money. (Gregory Mankiw, 2014, p. 571) Coupled with their power over interest rates the Bank of England theoretically through their sole creation of money can influence the spending patterns of the public and control inflation.

Thus here we can see the direct and unique ability possessed by the central bank to both print physical cash and also create digital money through quantitative easing, so undeniably within the UK economy, the Bank of England creates money – however, what we will now note is that this is neither the sole creator, nor the creator of the greatest quantity. For this reason we can allude that “it cannot perfectly control the money supply.” (Gregory Mankiw, 2014, p. 575)

What Orthodox Theory neglects: The role of Commercial Banks.

Orthodox economics acknowledges commercial banks but only as “merely intermediaries” (Josh Ryan-Collins, 2011, p. 20)between today and tomorrow and between savers and borrowers. The theory assumes that banks lend only once they have received the full amount in deposits and thus they serve the economy in this intermediating role and are unable to create ‘new money;. However, “viewing banks simply as intermediaries ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money.” (Michael McLeay, 2014, p. 15)

Central to the role of inter-mediating between savers and borrowers is the provision of credit by commercial banks to its customers. It may be conflicted that credit and ‘money’ are two highly differentiated entities and to collaborate the two is incorrect. However, reaffirming the definition of ‘money’ we are working from, one must confer in a modern society that “So long as markets are efficient, all forms of finance are equivalent — whether one uses income flows, debt, or equity is irrelevant.” (Wray, 2010, p. 34)

How do commercial banks create ‘money’?

The situation in the UK economy today is that commercial bank money “now makes up 97.4 percent of all the money used in the economy” (Josh Ryan-Collins, 2011, p. 15) which strongly highlights that it is in fact the commercial banks that ‘really make money in the economy.’ I will begin this section by exploring briefly the theory of the ‘money multiplier effect’ in attune to fractional reserve banking before debunking this and explaining how commercial banks actually create money in the economy.

Fractional reserve banking is a system that allows commercial banks to create ‘money’ in a manner under the supervision and control of the Bank of England. Thus, although it is under the capacity of the commercial banks to create the new ‘broad’ money, the total quantity of money in circulation is controlled by the central bank “by actively varying the quantity of reserves.” (Michael McLeay, 2014, p. 21) The equation: money multiplier = 1 / reserve requirement, illustrates that this process is calculated and controlled and thus ultimately the central bank retains control over the creation of money in the economy. The system implies that the commercial banks are able to create money in the economy but essentially it is an arm of power extended by the central bank which can be retracted.

However, “In the UK there are currently no direct compulsory cash-reserve requirements placed on banks” (Josh Ryan-Collins, 2011, p. 21) which currently declares the fractional system redundant. In reality the system broadly operates outside of the control of the central bank. Here is where we begin to understand the depth to the quote by Hyman Minsky referenced in ‘the classical view’ section of the essay.

Commercial banks in reality create money “whenever they lend to someone in the economy or buy an asset from consumers.” (Michael McLeay, 2014, p. 25) This occurs as when the Bank extends a loan to a customer, whether that occurs in the form of a collaterally backed mortgage, a direct bank loan or an overdraft. This liability of the bank, “simultaneously create(s) deposits in our bank accounts.” (Josh Ryan-Collins, 2011, p. 1) This deposit, as we know from experience, is accepted globally; we can purchase property, cars, groceries, even paying taxes and conducting all other transactions imaginable with these liabilities of the banks. When we look upon any bank note in our pockets, it reads “I promise to pay the bearer on demand the sum of …”and just as this liability of the Bank of England is of universal acceptance as currency, potentially as a bi-product of the central banks role as lender of last resort securitising the liabilities of the commercial banks, the credit created and distributed by the commercial banks has also came to be universally accepted as ‘money.’

This acceptance of commercial bank liabilities as ‘money’, coupled with ineffective monetary policy conducted by the Bank of England allowed the flow of money to escalate so that by “2006 there was £80 of commercial bank money for every £1 of base money.” (Josh Ryan-Collins, 2011, p. 22) This 80:1 ratio explains how the 2007 economic downturn rose to notoriety. Banks and other financial institutions took advantage of the ‘buy now, pay later’ mentality which has become common place in 21st century capitalism, and by exploiting their ability to create credit – placed this ‘money’ in the hands of those who ought not to possess it. This begs the question, what is in place to regulate the creation of money in the UK?

What restrains the creation of ‘money’?

In addition to the aforementioned monetary policy function held by the central bank to restrict the production of finance, commercial banks impose internal regulation upon themselves in order to ensure their own continuity. Although, as highlighted above, there are currently no compulsory reserve requirements imposed by the Bank of England it would be highly naïve to assume the commercial banks would be able to function were they not “to hold enough liquidity reserves and cash to meet their everyday demand for payments.” (Josh Ryan-Collins, 2011, p. 21) In order to operate efficiently commercial banks need to retain enough reserves to finance customer withdrawals, inter-bank lending and meet any central bank requirements and this certainly constrains their lending/creation of money. Equally, the recipients of credit impose an independent constraint on the ‘new money’ in the economy. This is independent as although monetary policy is able, to an extent, to influence the borrowing, spending and saving of consumers “the central bank cannot control or perfectly predict this behaviour.” (Gregory Mankiw, 2014, p. 575) Thus individuals operate as a separate constraint entirely. A point the next section of the essay will dispute, although classically it has been accurate is that; individuals are unable to create money, for example an IOU from an individual is incredibly unlikely to be accepted in shops, online or as payment for tax. However, individuals have the capacity to diminish the money supply as “the repayment of bank loans destroys money.” (Michael McLeay, 2014, p. 16) Theoretically this means independent of the central and commercial banks, the general public and businesses are able to decrease the money supply substantially. Therefore what this illustrates, in wake of the 2007 financial crisis, is that there are significant exercisable constraints over the creation of ‘money’.

What does the future hold for ‘money creation’ in the UK economy?

Classic literature debating this topic has traditionally been concluded here, and rightly so.  However, rising to prominence rapidly over the previous twelve months has been the crypto-currency market dragged onward by their market leader – Bitcoin. Due to the immaturity of the market in its development, currently I feel it leaves us with more questions than answers but a point for speculation none the less.

Although, as noted by Forbes; “In 2010, Bitcoin received recognition as a proper currency after merchants such as WordPress. Expedia and Microsoft began accepting it as a mode of payment.” (Stark, 2017) I contend that it is yet to meet the status of ‘money’ defined in the introduction of this essay as it is yet to receive universal acceptance, especially in the form of tax payments. However, it is quite conceivable that in the future the argument in favour of crypto-currency becoming ‘money’ could become increasingly compelling. The moral debate surrounding Bitcoin and the role played by it in certain transactions extends beyond the scope of this essay; however its emergence does have one major point of relevance:

“The true identity of the person or people behind Bitcoin remains unknown to this day.” (Bhunjun, 2017) Created under the guise of Satoshi Nakamoto, it is very much a mystery as to who the creator is or the creators are. For this reason, a rather worrying speculation means in reality, the ability to create ‘money’ is not retained by a central bank on behalf of a sovereign nation, nor is it limited to the extension of the commercial banks under a supervisory arm of regulation. The future may allow for anybody, with the necessary equipment and expertise, to ‘create money.’ We have seen in the wake of the 2007 financial crisis, an insight to the consequences of when regulation over the financial system is relaxed and the full force of monetary policy is not practiced. Crypto-currencies “are not controlled or regulated by some singular authority, their flow is determined entirely by market demand.” (Stark, 2017) This means that we are potentially leaning into a realm of ‘money’ in the UK produced by unknown entities under no fixed regulation which is startling.

Concluding remarks: who really creates ‘money’ in the UK economy?

What this article hopes to have illustrated is that the Bank of England has the unique ability to create physical currency for the UK economy and also the capacity to create huge influxes of money into the economy digitally via quantitative easing. Although critiquing the effectiveness of their chosen monetary policy in restraining the money production of commercial banks, we acknowledge that the Bank of England has the potential power to impose significant reserve requirements on the commercial banks and restrict their free production of credit money. However, we must overwhelmingly conclude by agreeing with the words of the Bank of England during 2007, that “by far the largest role in creating broad money is played by the banking sector” cited by (Josh Ryan-Collins, 2011, p. 16) as their liabilities have come to be universally accepted as ‘money’ and it is this form that overwhelmingly dominates the UK economy. The final remarks of this essay conceive that as the UK has already became “the third most cashless society in the world” (Christie, 2017) this could shift even more of the overwhelming power towards the commercial banks or equally fuel the rise of crypto-currencies as an alternative form of ‘money’ in the UK economy.


Bhunjun, A. (2017, 11 30). Metro.co.uk. Retrieved 01 04, 2018, from Who invented Bitcoin and who is mysterious founder, Satoshi Nakamoto?: http://metro.co.uk/2017/11/30/who-invented-bitcoin-and-who-is-mysterious-founder-satoshi-nakamoto-7119575/

BofE. (2017, 10 20). Quantitative easing. Retrieved 01 02, 2018, from Bank of England: https://www.bankofengland.co.uk/monetary-policy/quantitative-easing

Christie, S. (2017, 10 10). The 10 most cashless countries in the world – where does the UK rank? Retrieved 01 05, 2018, from The Telegraph: http://www.telegraph.co.uk/money/future-of-money/10-cashless-countries-world-does-uk-rank/

Gregory Mankiw, M. P. (2014). Economics. Warwick: Cengage Learning.

Josh Ryan-Collins, T. G. (2011). Where does money come from?: A guide to the UK Monetary & Banking system. London: New Economics Foundation.

Michael McLeay, A. R. (2014). Money creation in the modern economy. Bank of England, Quarterly Bulletin.

Minsky, H. (1957). Central Banking and Money Market Changes. The quarterly journal of Economics.

Stark, H. (2017, 04 21). Forbes.com. Retrieved 04 01, 2018, from From Here To Where? Bitcoin And The Future Of Cryptocurrency: https://www.forbes.com/sites/haroldstark/2017/04/21/from-here-to-where-bitcoin-and-the-future-of-cryptocurrency/#5ddfe6b04367

Wray, L. R. (2010). Alternative Approaches to Money. Theoretical Inquiries in Law 11.1 (2010).




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