Embedded Files
Helpful prior knowledge and learning objectives
Helpful prior knowledge and learning objectives
Helpful prior learning:
Section 1.1.1 The economy and you, which explains what an economy is and how it is relevant to students’ lives
Section 1.1.2 The embedded economy, which explains the relationship between the economy and society and Earth’s systems
Section 6.1.1 Money systems, which describes the parts, relationships and functions of money systems
Section 6.1.2 History of money systems, which outlines the historical origins of different money systems and their functions
Section S.1 What are systems?, which explains what a system is, the importance of systems boundaries, the difference between open and closed systems and the importance of systems thinking
Section S.2 Systems thinking patterns, which outlines the core components of systems thinking: distinctions (thing/other), systems (part/whole), relationships (action/reaction), and perspectives (point/view)
Learning objectives:
explain how forms of money are created in modern money systems
When people see a number in their bank account, that money doesn’t exist as cash in a vault. In most countries today, most money exists only as digital numbers. But where did it come from?
What forms of money exist today?
What forms of money exist today?
Money takes different forms. There’s physical cash, the coins and banknotes created by the state and central bank. This is legal tender, which means everyone must accept it as official payment.
But most money isn’t cash. It exists as numbers in your account or payment app. This is digital money, and it’s much more common than coins or notes. When you get paid, shop online, or send money to a friend, you’re using digital money.
More than 90% of the money in circulation is created by private commercial banks. When you see a number in your account, it’s really a promise from the bank: ‘We’ll give you cash if you ask for it.’ Central bank reserves are another kind of digital money used between banks, not by the public.
In most countries, all money in circulation is fiat money. That means it’s not backed by gold or another commodity. This hybrid system of public and private money creation only works because people trust that others will accept the money they use.
Figure 2. Different forms of money used today.
(Credit: Daniel Dan, Anthony, Pixabay, magr80, New Africa, Pexels license and licensed from Adobe Stock)
How is money created by private commercial banks?
How is money created by private commercial banks?
Many people think banks lend out money saved by others. Some school textbooks still teach this, and it’s implied in the circular flow of income model (Section 1.1.2). But that’s not how modern banking works.
When someone takes out a loan, the bank doesn’t hand over someone else’s savings. It creates new digital money by typing the amount into the borrower’s account. That money didn’t exist before.
This is credit money. It’s based on a promise: the bank promises the borrower can use the money now, as long as they repay it with interest. Borrowers can use it for many purposes: buying goods, paying wages, investing. As it circulates, it becomes part of the total money supply.
Figure 3. Commercial banks create new money every time they make a loan.
(Credit: Positive Money)
This means most of the money in the economy today begins life as a loan, so banks have a powerful privilege. They can create money themselves, and earn profit by charging interest on it. For example, someone borrows £10,000 at 7% interest for 10 years. Each year, they repay some of the original loan plus interest on the remaining amount. By the end, they might repay £14,000 or more, depending on the interest rate and structure. Borrowing is covered further in Section 6.4.4 (coming soon!).
Some economists argue that this profit-making power should come with stricter rules about what banks lend for and to whom, to better support people and planet (Section 6.3.5 - coming soon!). Others warn that when nearly all money is created as debt, it forces constant economic growth just to keep up (Section 5.3.2). This can worsen inequality and encourage harmful activities.
What is the role of central banks and states?
What is the role of central banks and states?
Central banks and states shape money systems in two broad ways: they create some money themselves and set the rules for how commercial banks create money through lending.
Creating money
Creating money
States and central banks issue coins and banknotes, the legal tender. Many national governments also create money when they spend. For example, when they fund schools, healthcare, or green energy, most national governments spend first and collect taxes later. Taxes are important for other reasons, but tax money often doesn’t need to come before national government spending.
Not all governments have the same power to create money through spending. Countries that issue their own currency and borrow mainly in that same currency, like the United States and the United Kingdom, have more control. Other countries, especially those borrowing in foreign currencies, face more limits and risks. And local and regional governments generally cannot create money through spending at all. Section 6.3.6 (coming soon!) explores state financing further.
Regulating and guiding commercial banks
Regulating and guiding commercial banks
Central banks support the money system in the background. Commercial banks must have accounts at the central bank. These accounts hold reserves, a kind of digital money used only between banks. These reserves are used to settle payments between banks, for example, if you send money to someone else who has an account at a different bank.
Central banks set reserve requirements, such as requiring $1 in reserves for every $100 of digital money created through loans. This limits how much money banks can create.
If a bank doesn’t have enough reserves, it can borrow them from the central bank or from another bank’s reserve account. The interest rate charged is called the policy rate, and it’s the main tool central banks use to guide the economy. Lower policy rates reduce borrowing costs, which encourages borrowing and creates more money. Higher rates discourage borrowing and slow money creation.
Some governments and central banks go further, encouraging lending for public goals such as clean energy or affordable housing. This is called credit guidance. Moving toward regenerative economies will likely require more guidance of this kind (Section 6.3.5 - coming soon!).
Through all these actions—creating some money, influencing interest rates, and setting rules—central banks and states help shape how much money exists, where it flows, and what kind of economy it supports.
What are the risks of creating modern money?
What are the risks of creating modern money?
The biggest risk is inflation, when average prices rise (Section 5.3.6). This can happen when too much money chases too few goods and services. If people have too much money to spend and demand is high, sellers will have more power to raise prices (Section 3.1.2). Inflation can also result from disruptions in supply chains, energy shocks, war, or climate disasters. These often happen together.
Money creation is a tool. Used wisely to invest in education, health, green energy and ecological restoration, it can improve people’s lives and regenerate Earth systems. But today, much new money fuels activities that harm people and the planet: weapons production, addictive products, and speculative finance. We also face planetary boundaries. If money is created to grow economies without limits, it can worsen environmental harm and deepen inequality (Section 6.1.5).
So the real question is not only how much money is created, but by whom, and for what. Understanding how money is created today gives us tools to think about designing money systems that support people and planet. Regenerative proposals are explored in Subtopic 6.3 (coming soon!).
Figure 5. Credit money creation for oil drilling is pushing us past planetary boundaries.
(Credit: Jan-Rune Smenes Reite, Pexels license)
Activity 6.1.3
Activity 6.1.3
Concept: Systems
Skills: Thinking skills (critical thinking)
Time: varies, depending on option
Type: Individual, pairs, or small group
Option 1: The story of the eleventh round
Time: 35-40 minutes
A long time ago, there was a village where people lived without money. They traded eggs for bread, helped each other fix roofs, and shared what they had. No one kept track of who owed what, because they trusted each other and gave help when it was needed.
One day, a man in shiny shoes and a white hat arrived. He watched the villagers trade chickens and laughed. “You people are wasting so much time,” he said. “I can help you.”
He asked for a big piece of leather, cut it into small circles, and stamped each one. He gave ten leather rounds to every family. “Each one is worth one chicken,” he explained. “Now you can trade more easily.”
The villagers were impressed. But before he left, the man added, “Next year, I want one extra round back from each of you — eleven instead of ten. That’s my fee.”
One woman asked, “But you only gave out ten rounds. How can we give you eleven?”
“You’ll figure it out,” he said with a smile.
At first, life seemed easier. People liked using the rounds instead of chickens. But by the end of the year, not everyone could pay back eleven rounds. Some families had to give up all their rounds to others. They were left with nothing.
Neighbours became less generous. Helping others might mean losing your own eleventh round. Slowly, trust and cooperation began to disappear. All because of one missing round.
Questions to discuss:
What problem does the story highlight about how money is created by commercial banks with interest?
Why couldn’t everyone pay back the eleventh round, even if they worked hard?
How did the introduction of money affect the relationships in the village?
What does this story suggest about competition, cooperation, and debt?
If you were a policymaker, what lessons would you take from this story?
Click on the arrow to check your and your groups work with sample answers, but have a go yourself first!
1. What problem does the story highlight about how money is created by commercial banks with interest?
The story shows that when money is created through loans with interest, more money is expected to be paid back than was created. This creates a built-in problem: not everyone can pay back what they owe because the “extra” money to pay the interest doesn’t exist yet. It means someone has to lose for others to win.
2. Why couldn’t everyone pay back the eleventh round, even if they worked hard?
Because the stranger only gave out 10 rounds to each family, and asked for 11 back, there weren’t enough rounds in the system for everyone to succeed. Even if all the families were honest and worked hard, at least one of them would have to lose their rounds for others to pay the extra. It wasn’t about effort — it was about how the system was set up.
3. How did the introduction of money affect the relationships in the village?
Before money, people helped each other without worrying about getting something back right away. But once the money system was introduced, and especially with the pressure to pay back interest, people became more competitive. They were less willing to help neighbours because they were all trying to hold on to their rounds. Trust and cooperation began to break down.
4. What does this story suggest about competition, cooperation, and debt?
The story suggests that debt with interest can create competition, even when people don’t want to compete. It can damage community life by making people think more about protecting their own money than supporting each other. It raises questions about whether our money systems encourage the kind of behaviour that helps society or harms it.
5. If you were a policymaker, what lessons would you take from this story?
I would think carefully about how money is created and whether it helps or hurts people’s ability to live well together. Maybe we need systems that don’t rely so much on debt with interest. I’d also look for ways to support cooperation — not just competition — so that money helps build strong communities instead of weakening them.
Option 2: Who should be able to create new money?
Time: 30 minutes
Commercial banks create most of the money in circulation by issuing loans and charging interest. This gives them profit and a lot of power. But money is essential for life. Should private banks keep this power, or should money creation be a public responsibility?
Read each argument below.
Decide whether it supports:
– keeping money creation in private hands
– making money creation a public service
– both
– or neitherDiscuss your choices with a partner or small group. Are there trade-offs or complexities that don’t fit neatly on either side?
Arguments to classify:
Banks usually lend to people or businesses that already have assets or income. (argument for commercial bank money lending / argument for public lending / neither or both)
It could be risky to give governments full control over money creation. (argument for commercial bank money lending / argument for public lending / neither or both)
Skilled loan officers help banks judge which loans are safe and which are not. (argument for commercial bank money lending / argument for public lending / neither or both)
When governments invest in health, education, or climate adaptation, the whole society benefits. (argument for commercial bank money lending / argument for public lending / neither or both)
A system where banks compete can make borrowing easier and more responsive to different needs. (argument for commercial bank money lending / argument for public lending / neither or both)
Financial crises have shown that private banks don’t always act in the public interest. (argument for commercial bank money lending / argument for public lending / neither or both)
Good money systems depend on public trust, no matter who creates the money. (argument for commercial bank money lending / argument for public lending / neither or both)
Creating money should help societies meet shared goals, not only generate profit. (argument for commercial bank money lending / argument for public lending / neither or both)
Follow-up discussion:
Which arguments were strongest for you?
Do you think money creation should be left to banks, or made a public responsibility, or something in between?
Click below for sample answers and explanations, but have a go yourself first!
1. Banks usually lend to people or businesses that already have assets or income.
Argument for making money creation a public service
Explanation: This points out that banks often favour those who already have wealth. If money creation were public, lending could be guided more by need and fairness, rather than profit, helping to reduce inequality.
2. It would be risky to give governments full control over money creation.
Argument for keeping money creation in private hands
Explanation: Some worry that governments might misuse this power, spending too much for political reasons or ignoring long-term consequences. This argument supports limiting government control to protect the economy from political pressure.
3. Skilled loan officers help banks judge which loans are safe and which are not.
Argument for keeping money creation in private hands
Explanation: Banks are used to judging financial risk and deciding who can repay loans. If governments created money instead, some fear decisions might be less based on risk and more on politics or popularity.
4. When governments invest in health, education, or climate adaptation, the whole society benefits.
Argument for making money creation a public service
Explanation: This supports the idea that public money creation could help fund essential services and projects that benefit everyone, especially during emergencies or for long-term wellbeing.
5. A system where banks compete can make borrowing easier and more responsive to different needs.
Argument for keeping money creation in private hands
Explanation: This argues that competition between banks encourages innovation, better services, and more lending options. A public-only system might be slower or less flexible.
6. Financial crises have shown that private banks don’t always act in the public interest.
Argument for making money creation a public service
Explanation: This reminds us that private banks have sometimes taken big risks that caused economic crashes. When banks create money mainly to seek profit, it can harm the whole economy. A public system might focus more on long-term stability and wellbeing.
7. Good money systems depend on public trust—no matter who creates the money.
Argument that supports both public and private money creation
Explanation: This highlights a shared challenge. Whether money is created by banks or the government, people need to trust that it will be stable, accepted, and fairly managed. Both systems must earn and maintain that trust.
8. Creating money should help societies meet shared goals, not only generate profit.
Argument for making money creation a public service
Explanation: This is a values-based argument. It suggests that money is too important to leave to private profit alone. A public approach could align money creation with goals like fairness, sustainability, and community wellbeing.
Ideas for longer activities and projects are listed in Subtopic 6.5
Checking for understanding
Checking for understanding
Further exploration
Further exploration
What is money? - Positive Money video about how money is created
Finding the Money - add description
SystemShift Podcast Episode 2 - The Story of Money with Ann Pettifor - add description
Money for Beginners: An Illustrated Guide - A graphic introduction to money systems written by economist Randall Wray. It explains how money is created, how it works in modern economies, and how our understanding of money has changed over time. A great way to dive deeper using storytelling and illustrations. Difficulty level: easy/medium
Sources
Sources
Bank of England. (2019, October 1). How is money created? https://www.bankofengland.co.uk/explainers/how-is-money-created
Barinaga. E. (2024). Remaking Money for a Sustainable Future. Bristol University Press. https://library.oapen.org/viewer/web/viewer.html?file=/bitstream/handle/20.500.12657/89799/9781529225402.pdf?sequence=1&isAllowed=y
Graeber, D. (2014). Debt: The first 5,000 years. Melville House.
Hochschule für Gesellschaftsgestaltung. (2024). Was ist Geld? https://hfgg.de/impact/digitaler-transformations-campus/
Jakab, Z., & Kumhof, M. (2018, October 26). Banks are not intermediaries of loanable funds: Facts, theory, and evidence (Staff Working Paper No. 761). Bank of England. https://www.bankofengland.co.uk/working-paper/2018/banks-are-not-intermediaries-of-loanable-funds-facts-theory-and-evidence
Kelton, S. (2021). The deficit myth. John Murray.
Lietaer, B. (2010). Monetary literacy 101 – A short introduction to the why? and how? of reforming money (Working paper). Currency Solutions for a Wiser World. https://bernard-lietaer.org/wp-content/uploads/2022/07/Monetary-Literacy-101-Lietaer2010.pdf
Martin, F. (2014). Money: The unauthorised biography. Vintage.
McLeay, M., Radia, A., & Thomas, R. (2014). Money creation in the modern economy. Bank of England Quarterly Bulletin, 54(1), 14–27. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
Pettifor, A. (2017). The production of money. Verso.
Raworth, K. (2017). Doughnut economics: seven ways to think like a 21st century economist. London: Penguin Random House.
Reardon, J., Caporale, M. M. A., & Cato, M. S. (2018). Introducing a new economics: Pluralist, sustainable and Progressive. London: Pluto Press.
van Staveren, I. (2015). Economics after the crisis: An introduction to economics from a pluralist and global perspective. Routledge.
Stevens, M. Bowles, S, and Carlin. (2024). 6.8 Money creation in a modern economy. The Economy 2.0. https://www.core-econ.org/the-economy/macroeconomics/06-financial-sector-08-money-creation-in-modern-economy.html
Wray, L. R. (2022). Making money work for us: How MMT can save America. Polity Press.
Wray, L. R., & van Doornen, H. (2023). Money for beginners: An illustrated guide. John Wiley & Sons
Terminology (in order of appearance)
Terminology (in order of appearance)
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