Money creation is the process by which the money supply in an economy is increased. It involves producing and introducing currency such as coins, paper notes, and electronic money used as a medium of exchange for goods and services
. In modern economies, money creation primarily happens in two ways:
- Central Bank Money Creation: Central banks create money by issuing reserve deposits, which are electronic balances held by commercial banks at the central bank. They can increase these reserves by lending to banks, purchasing assets, or other accounting entries. Central bank money includes physical cash and these electronic reserves
- Commercial Bank Money Creation: The majority of money used by the public is created by commercial banks when they provide loans. When a bank grants a loan, it credits the borrower's account with a deposit, effectively creating new money electronically. This deposit did not exist before the loan was made. As loans are repaid, this money is destroyed. This process is often called money creation through bank lending or the credit multiplier effect
Only a small fraction of money exists as physical currency; most money exists as electronic bank deposits created through lending. Banks do not simply lend out existing deposits; they create new deposits when they issue loans. However, banks are regulated and cannot create unlimited money-they must hold sufficient capital and manage liquidity risks
. In summary, money creation is mostly about banks expanding their balance sheets by issuing loans, which creates new deposits (money) in the economy, while central banks control the overall money supply through policy tools and reserve management
