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Home » Monetary Literacy 101

Who creates money?

Submitted by on September 17, 2010 – 6:45 amNo Comment

Contrary to popular belief, governments do not create money in our current system.   As a matter of fact, whenever the revenues generated by taxes are inferior to their outlays, governments have to borrow money from the general public through the bond market, or through the banking system.

Money is actually created by the banking system. A country’s banking system includes the banks themselves and the central bank that supervises the banks incorporated in its jurisdiction.   In the case of the US, the central bank is the Federal Reserve Bank.

In essence, new money is produced each time a new loan is approved by the banking system either for the private or the public sector.  It is called fiat money because it is money created “out of nothing”. Since only a small part of the money is drawn from bank deposits (typically less than 10%), the balance (more than 90%) is created through the fractional reserve system.  This means that only a small part of the money lent originates from the reserves of the bank.