Readers question on: Where and Who Creates Money?

“Where and who creates the money?” Looks like Newton’s “Law of conservation of energy: Energy never be created nor destroyed”. To be more clear, I will explain with 2 examples.

First case : I work in a big retail company in USA and get paid bi-weekly. How my company is getting money? Retail company makes profit from some % of the money they got from the customer after selling an item. This customer gets money as a salary or as profit if he do business and so. That means money is just rotating. Never created.

Second case : Let us say I have some $70K property (as of today) which includes bank balance+car cost+ cost of households etc. Like this, every one in USA has some property. If I add all this individual properties of all people or families in USA, let us say it comes to an ‘X’ dollars as on today. If we calculate the same total amount on a day for 20 years back, it will definitely be less. So money is created as the time goes on.

The two examples are conflicting. Money is never created in 1st case, Money is created in 2nd case. Which is right and how it suffice with other example? Can any one answer?

First of all it is useful to understand money, real income and actual output.

  • Money is simply the amount of cash (plus bank deposits you have)
  • Output is the quantity of goods and services a society produces.
  • Real income shows the effective level of wages that you get. A rise in real income means that the amount of money you get is increasing faster than the average level of prices in an economy.

You can create ‘money’ simply by the Central Bank printing more notes. However, increasing the supply of money doesn’t necessarily create more output, it simply means people have more money to buy the same amount of goods. This tends to cause inflation. (see: link between money supply and inflation)

Therefore, creating money is easy, but it doesn’t automatically translate into better living standards.

We can create more output, higher incomes and better living standards through economic growth.

Imagine a simple economy where everyone grows their own food. Here there may no money used at all. People’s living standards are limited to just consuming the food they grow. We would say their income and wealth is very low.

Technological change

Suppose someone developed a new technology which enabled them to grow 100* more food. This means in a community you would only need 1 person to work as a farmer growing food rather than everyone work as a farmer. This means the other 99 people would be free to start producing other goods. They could produce machines and offer services to the farmer. The farmer could sell his produce to those working in other fields. Then the society would have much greater output than just food.

Therefore, economic growth (increase in real incomes) often comes about as people specialise in producing certain goods and services. When we produce things more efficiently, we can produce a greater quantity of goods and services. In this sense greater efficiency helps society to be better off, meaning people have more income.

Case One

If your company becamse more efficient in making goods (e.g. assembly line which made it much quicker to produce cars), it could sell them at a lower prices. Then more people would be able to afford to buy a car. They would also have more income left over to buy other goods.

In 1910, only the very rich could afford cars. In the 1920s, the assembly line made buying a car much more accessible and affordable. Therefore living standards rose. Technology like the assembly line enables greater levels of income and output in society.

Case Two

In case two the rise in the price of houses maybe because people are gaining a rise in real incomes and therefore they have more income to spend on buying houses. This pushes up prices reflecting the increase in real incomes in society

1 thought on “Readers question on: Where and Who Creates Money?”

Leave a comment

Item added to cart.
0 items - £0.00