Transcript
INTERVIEWER:
Ryland, your article is about how money gets created. We're surrounded here by gold in the vaults of the Bank of England. And historically in the gold standard, the amount of gold would have been related to the stock of money in the economy. Things are very different now. In the modern economy, where does money come from?
RYLAND THOMAS:
Well, let's start off with narrow or central bank money. As the name suggests, central bank money is determined by the Bank of England and consists of notes and reserves. And in normal times at least, notes and reserves are determined by the amount of notes that people want to hold or need for their transactions and the amount of notes and reserves that banks want to hold given the level of interest rates in the economy. It is not chosen or fixed by the central bank as is sometimes described in some economics textbooks.
INTERVIEWER:
Your article focuses on broad money. What determines how much of that there is?
RYLAND THOMAS:
Well, broad money, which in many ways is a better measure of the amount of money circulating in the economy, includes all the bank deposits of households and companies. And one of the key points of the article is that banks create additional broad money whenever they make a loan.
Now while this is nothing new, it is sometimes overlooked as the main way in which money is created and it runs contrary to the view sometimes put forward that banks can only lend out deposits that they already have. In fact, loans create deposits - not the other way around.
INTERVIEWER:
Now your article explains in more detail how lending creates money. It also explains how there are limits to how much banks are likely to create new money as a result of lending. These could be profitability considerations of the banks themselves through to how households and companies react in aggregate to having increased deposits as a result of higher lending.
RYLAND THOMAS:
That's right.
INTERVIEWER:
So if banks create money through lending, what then is the role of the monetary policy of the central bank in this story?
RYLAND THOMAS:
Well, you mentioned some of the limits to how much banks will lend in practice. Well, monetary policy provides the ultimate limit. Now in normal times-- say, before the Great Recession-- monetary policies is set through interest rates, and that determines the loan rates that are faced by borrowers in the economy and the amount of interest that banks pay out to depositors. And this directly affects the amount of lending that goes on in the economy and the amount of broad money that's created as a result.