Table Of Content“Refreshing and clear. The way monetary economics and banking is taught
in many — maybe most — universities is very misleading and what this
book does is help people explain how the mechanics of the system work.”
David Miles, Monetary Policy Committee, Bank of England
“It is amazing that more than a century after Hartley Withers’s ‘The
Meaning of Money’ and 80 years after Keynes’s ‘Treatise on Money’, the
fundamentals of how banks create money still need to be explained. Yet
there plainly is such a need, and this book meets that need, with clear
exposition and expert marshalling of the relevant facts. Warmly
recommended to the simply curious, the socially concerned, students and
those who believe themselves experts, alike. Everyone can learn from it.”
Victoria Chick, Emeritus Professor of Economics, University College London
“I used ‘Where Does Money Come From?’ as the core text on my second
year undergraduate module in Money and Banking. The students loved it.
Not only does it present a clear alternative to the standard textbook view of
money, but argues it clearly and simply with detailed attention to the actual
behaviour and functioning of the banking system. Highly recommended for
teaching the subject.”
Dr Andy Denis, Director of Undergraduate Studies, Economics Department, City University,
London
“By far the largest role in creating broad money is played by the banking
sector... when banks make loans they create additional deposits for those
that have borrowed.”
Bank of England (2007)
WHERE DOES MONEY COME FROM?
A GUIDE TO THE UK MONETARY AND
BANKING SYSTEM
JOSH RYAN-COLLINS
TONY GREENHAM
RICHARD WERNER
ANDREW JACKSON
FOREWORD BY
CHARLES A.E. GOODHART
Where Does Money Come From?
Second edition published in Great Britain in 2012 by
nef (the new economics foundation).
Reprinted 2011
The moral right of Josh Ryan-Collins, Tony Greenham, Richard Werner and Andrew Jackson to be
identified as the authors of this work has been asserted by them in accordance with the Copyright,
Designs and Patents Acts of 1988.
Some rights reserved. No part of this publication may be reproduced, stored in a retrieval system or
transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or
otherwise for commercial purposes without the prior permission of the publisher. This book is
Licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Unported License.
Every effort has been made to trace or contact all copyright holders.
The publishers will be pleased to make good any omissions or rectify any mistakes brought to their
attention at the earliest opportunity.
British Library Cataloguing in Publication Data. A catalogue record for this book is available from
the British Library.
ISBN: 978 190850 623 8 (Print)
new economics foundation
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© September 2011 nef (the new economics foundation)
Acknowledgements
The authors would like to thank Ben Dyson for his valuable contributions to
the writing of this book.
We are also most grateful to Professor Victoria Chick, Jon Relleen, James
Meadway, Professor Charles Goodhart, Mark Burton and Sue Charman for
their helpful insights and comments.
Our thanks go to Angie Greenham for invaluable assistance with editing,
proofing and production control and to Peter Greenwood at The Departure
Lounge for design and layout.
Finally, we would like to express our gratitude to James Bruges and Marion
Wells, without whom the book would not have been written.
CONTENTS
FOREWORD
1. INTRODUCTION
1.1. Key questions
1.2. Overview of key findings
1.2.1. The money supply and how it is created
1.2.2. Popular misconceptions of banking
1.3. How the book is structured
2. WHAT DO BANKS DO?
2.1. The confusion around banking
2.2. Popular perceptions of banking 1: the safe-deposit box
2.2.1. We do not own the money we have put in the bank
2.3. Popular perceptions of banking 2: taking money from savers and
lending it to borrowers
2.4. Three forms of money
2.5. How banks create money by extending credit
2.6. Textbook descriptions: the multiplier model
2.7. Problems with the textbook model
2.8. How money is actually created
3. THE NATURE AND HISTORY OF MONEY AND BANKING
3.1. The functions of money
3.2. Commodity theory of money: money as natural and neutral
3.2.1. Classical economics and money
3.2.2. Neo-classical economics and money
3.2.3. Problems with the orthodox story
3.3. Credit theory of money: money as a social relationship
3.3.1. Money as credit: historical evidence
3.3.2. The role of the state in defining money
3.4. Key historical developments: promissory notes, fractional
reserves and bonds
3.4.1. Promissory notes
3.4.2. Fractional reserve banking
3.4.3. Bond issuance and the creation of the Bank of England
3.5. Early monetary policy: the Bullionist debates and 1844 Act
3.6. Twentieth century: the decline of gold, deregulation and the rise
of digital money
3.6.1. A brief history of exchange rate regimes
3.6.2. WWI, the abandonment of the gold standard and the regulation of
credit
3.6.3. Deregulation of the banking sector in the 1970s and 1980s
3.6.4. The emergence of digital money
4. MONEY AND BANKING TODAY
4.1. Liquidity, Goodhart’s law, and the problem of defining money
4.2. Banks as the creators of money as credit
4.3. Payment: using central bank reserves for interbank payment
4.3.1. Interbank clearing: reducing the need for central bank reserves
4.3.2. Effects on the money supply
4.4. Cash and seignorage
4.4.1. Is cash a source of ‘debt-free’ money?
4.5. How do banks decide how much central bank money they need?
4.6. Is commercial bank money as good as central bank money?
4.6.1. Deposit insurance
4.7. Managing money: repos, open market operations, and
quantitative easing (QE)
4.7.1. Repos and open market operations
4.7.2. Standing facilities
4.7.3. Quantitative Easing
4.7.4. Discount Window Facility
4.8. Managing money: solvency and capital
4.8.1. Bank profits, payments to staff and shareholders and the money
supply
4.9. Summary: liquidity and capital constraints on money creation
5. REGULATING MONEY CREATION AND ALLOCATION
5.1. Protecting against insolvency: capital adequacy rules
5.1.1. Why capital adequacy requirements do not limit credit creation
5.1.2. Leverage Ratios: a variant of capital adequacy rules
5.2. Regulating liquidity
5.2.1. Compulsory reserve ratios
5.2.2. Sterling stock liquidity regime (SLR)
5.3. Securitisation, shadow banking and the financial crisis
5.4. The financial crisis as a solvency and liquidity crisis
5.5. Endogenous versus exogenous money
5.6. Credit rationing, allocation and the Quantity Theory of Credit
5.7. Regulating bank credit directly: international examples
6. GOVERNMENT FINANCE AND FOREIGN EXCHANGE
6.1. The European Union and restrictions on government money
creation
6.1.1. The Eurozone crisis and the politics of monetary policy
6.2. Government taxes, borrowing and spending (fiscal policy)
6.2.1. Taxation
6.2.2. Borrowing
6.2.3. Government spending and idle balances
6.3. The effect of government borrowing on the money supply:
‘crowding out’
6.3.1. Linking fiscal policy to increased credit creation
6.4. Foreign exchange, international capital flows and the effects on
money
6.4.1. Foreign exchange payments
6.4.2. Different exchange rate regimes
6.4.3. Government intervention to manage exchange rates and the
‘impossible trinity’
6.5. Summary
7. CONCLUSIONS
7.1. The history of money: credit or commodity?
7.2. What counts as money: drawing the line
7.3. Money is a social relationship backed by the state
7.4. Implications for banking regulation and reforming the current
system
7.5. Towards effective reform: Questions to consider
7.6. Are there alternatives to the current system?
7.6.1. Government borrowing directly from commercial banks
7.6.2. Central bank credit creation for public spending
7.6.3. Money-financed fiscal expenditure
7.6.4. Regional or local money systems
7.7. Understanding money and banking
APPENDIX 1:
THE CENTRAL BANK’S INTEREST RATE REGIME
A1.1. Setting interest rates – demand-driven central bank money
