Readers Question: What is Creating money electronically?
Creating money electronically is something a Central Bank can do when pursuing a policy of quantitative easing. It basically involves making its bank balance bigger.
In quantitative easing, the Central Bank wishes to increase the money supply and purchases bonds from commercial banks.
The Central Bank will decide to increase it’s level of bank reserves. E.g. suppose it was £100bn. The Central Bank can simply decided to change this figure to £120bn. It’s like going into your bank account and changing your savings account. Instead of having £200 in the bank, you could decide to have £20,000. Except you don’t have the power, the Central Bank does.
Therefore, by increasing the amount of reserves the Central Bank has it can use this created money to buy bonds from commercial banks. Commercial banks accept this electronic transfer of money from the Central Bank to buy their bonds. The Central bank is responsible for overseeing the supply of money in the economy.
The effect is similar to printing money. The Central Bank could order the people who print banknotes to print an extra £20bn in notes. All this extra money could be then deposited in the Central Bank’s account. The effect would be the same – increasing their bank balance from £100bn to £120bn.
Electronically creating money misses out this step of physically printing the money and depositing in the Central Bank.
So when you’re mother and father tells you money doesn’t grow on trees, you can tell them all about quantitative easing and electronic creation of money.
Of course, electronically creating money doesn’t increase actual output. The purpose of money creation is to try and encourage commercial bank lending and avoid deflationary traps. The concern is that increasing money supply could lead to inflation (printing money and inflation) However, evidence from the 2009-10 experiment of quantitative easing is that when the Central Bank created money and bought bonds, commercial banks simply kept most of this extra money and little filtered through into the wider economy.
- Where and Who Creates Money? – Another readers question on the creation of money