Banks and The Creation of Money

Readers Question: Is it right that private banks can create 97% of all new money by lending it into existence, and what effect does this have on inflation and the value of money already in existence ?

It is true, that banks can effectively increase the money supply, by lending out say 97% of all deposits.

If you deposit £1,000. The bank may keep only a reserve of 3% (£30).

This means they can lend out £970 to other people. However, this means that banks will have additional deposits in the future. Therefore, when this £970 gets deposite they can again lend out 97% of the value.

There is a fuller explanation at Wikipedia on Money Creation

In practise the money multiplier is less than the inverse of the reserve ratio – Money multiplier and reserve ratio

Effect on Inflation of Money Supply

If there is an increase in the Money supply, it could cause inflation. If money supply rises much faster than the long run trend rate of real output, then inflation is likely to occur.

see: Inflation and Money Supply