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 digital money didn’t exist before.
This is credit money. It’s based on two promises: the bank promises to pay cash on demand in the amount of the digital money. In exchange, the borrower promises to repay the money later with interest. Borrowers can use it for many purposes like buying goods, paying wages, and 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)
When the loan is repaid, the process runs in reverse. The bank removes the loan and the matching deposit from its records, and that digital money stops existing. This is why the amount of money in the economy depends on banks continually making new loans. Each repayment removes money, and each new loan adds it back.
The interest is different. It isn't cancelled out the way the loan is. Someone who borrows £10,000 at 7% interest over 10 years might repay £14,000 or more by the end, depending on the interest rate and how much of the loan they pay off each month or year. The extra amount, on top of the original £10,000, is the bank's interest income. As the bank spends on wages for staff, paying profits (dividends) to shareholders, or interest to its own depositors, the money flows back into the economy. Whoever receives that money can then spend it, save it, or lend it again.
What happens next depends on where that money goes, and how quickly it keeps moving once it gets there. Economists call this pace the velocity of money. If money keeps moving, spent, earned, spent again, or lent out and spent by someone else, the system can stay stable. Velocity depends on how much people hold their money idle rather than spend or lend it out. People and institutions with a lot of money tend to hold a larger idle share than people with little money, who usually spend most of what they earn fairly quickly. So when interest income flows mainly toward those who already have a lot of money, more of it can sit unused rather than circulate. That slows the velocity of money across the economy as a whole.
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 technically tax money doesn’t need to come in before national governments spend.
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, though they might create rules that limit the creation of money by the state. Other countries, especially those borrowing in foreign currencies, face more limits and risks. And local and regional governments generally cannot create money through spending. Section 6.3.6 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 hold accounts at the central bank. These accounts contain reserves, a type of digital money that circulates only between banks. Reserves are used to settle payments between banks, for example when you transfer money to someone who uses a different bank.
When a commercial bank makes a loan, it creates new deposits for the borrower. This expands the money supply. Banks are allowed to create this digital money, but only within rules that protect the stability of the system. One key rule focuses on bank capital. Capital is the bank’s own money that belongs to its owners or shareholders. It acts as a loss-absorbing cushion. If borrowers don’t repay loans, losses are taken from capital rather than from customers’ deposits. Regulations also require banks to hold enough liquid assets. These are assets that can quickly be turned into money to meet payments and withdrawals, such as reserves or government bonds. Together, capital and liquidity rules shape how much and to whom banks can lend.
If a bank needs additional reserves for settlement, it can borrow them from other banks or from the central bank. The interest rate on these short-term loans is called the policy rate. By adjusting this rate, central banks affect how much new money is created by commercial banks. 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)
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 modern money creation?
What are the risks of modern money creation?
One 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.
Another risk is that debt-based money creation tends to fuel activities that harm people and the planet: weapons production, addictive products, and speculative finance. These extractive activities earn high profits, and make it more likely that loans will be repaid. So the way we create money is directly linked to the weakening of our social and ecological systems (Section 6.1.4 and Section 6.1.5). Some economists argue that the profit-making power of banks should come with stricter rules about what banks lend for and to whom, to better support people and planet (Section 6.3.5).
Figure 6. Credit money creation for oil drilling is pushing us past planetary boundaries.
(Credit: Jan-Rune Smenes Reite, Pexels license)
Another concern is about where the interest that banks earn ends up. Wealthier households and institutions usually spend or relend a smaller share of their money each year. So when interest income flows mainly to people who already have a lot of money, it can circulate more slowly in the economy. Some economists argue that an economy might need more and more new lending just to keep demand up. If new lending then slows, incomes and spending can fall. Borrowers may not be able to pay their loans, called default. When many borrowers default at the same time, banks and lenders have less money coming in. That makes them lend less and can put them under pressure themselves. Businesses that rely on loans or on customers spending money can struggle too. This is how one part of the economy running into trouble can spread and become an economic crisis.
So when we think about modern money creation we need to consider not only how much money is created, but by whom, for what purposes, and under what conditions and rules? Understanding these questions gives us insights to design money systems that better support people and planet (Subtopic 6.3)
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
This is a well-known parable about money and debt. It has been used for years to argue that a system where money is created as debt with interest cannot last. It is not a true story, but was written to make a point. Simple stories can feel true even when they leave out important details. As you read, ask yourself what this story is assuming, and what it might be leaving out about how money is created and the impact of that system. Some questions at the end can support your thinking.
The story
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:
The story doesn't say what the moneylender does with the rounds he collects. Using what you've read in this section, describe two different things that could happen to those rounds, and how each one changes the story's ending.
The story describes all families paying back at the same time. Is that how borrowing in the economy actually works? What if families borrowed and repaid at different points during the year?
If the moneylender lent the collected rounds to new families the following year, would the total number of rounds in circulation stay fixed, or could it change?
The story's ending says neighbours became less generous once rounds grew scarce. If villagers start holding onto their rounds instead of spending or lending them to each other, what happens to how quickly rounds move through the village?
Rewrite the ending of the story: what happens after the families hand over their eleven rounds? Does the 'someone must lose' outcome still have to happen? Describe what changes, in 3-4 sentences.
Click on the arrow to check your and your group's work with sample answers, but give it a go yourself first!
Q1: One option is that the moneylender keeps the rounds and never spends them. In that case, the story's ending holds. Another option is that the moneylender spends or relends the rounds back into the village. The rounds then reach other villagers, who can use them to pay their own debts or buy goods. The same rounds keep moving instead of disappearing. The current ending of the story only makes sense if the moneylender holds onto the rounds.
Q2: No. In real life, people take out loans and repay them at different times. If families borrowed and repaid on a rolling basis rather than all at once, a family repaying in March could be using rounds that a different family only borrowed in January, then earned through trade in February. Not everyone needs to hold an extra round at the exact same moment for the system to keep working.
Q3: It could grow. If the moneylender relends the rounds he collects, and perhaps creates new ones for new borrowers, more rounds enter the village over time. The story assumes a fixed pool of ten rounds forever. That assumption doesn't have to hold in a real, ongoing economy.
Q4: If villagers hold onto their rounds instead of spending or lending them, rounds move through the village more slowly. Fewer rounds change hands, so it becomes harder for any family to earn the extra round they need. This makes the shortage worse, not better. Whether the ending is 'someone must lose' or not depends on whether rounds keep moving or start to sit still, and that depends on how both the moneylender and the villagers behave.
Q5: Answers will vary, but a strong answer will show that the outcome depends on what the moneylender does with the rounds, whether villagers keep lending and spending or start holding onto what they have, and whether lending and repayment happen all at once or over time. The 'someone must lose' conclusion happens if rounds stop moving, whether because the moneylender hoards them or because fear or lack of trust causes villagers do the same. Keep rounds circulating and the outcome changes.
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)
Link to Quizlet interactive flashcards and terminology games for Section 6.1.3 Modern money creation
state: a system that provides essential public services, and also governs and regulates other economic institutions
central bank: the main bank of a country (or group of countries) that manages money, interest rates, and financial stability
legal tender: money that the law says must be accepted to settle debts, such as state-issued coins and banknotes
commercial bank: a private bank that creates most new money by issuing loans and manages accounts for people and businesses
fiat money: money that is not backed by gold or other commodities and works because people trust and accept it under shared rules
circular flow of income model: a model showing the flow of money and resources or products back and forth between businesses and households and other economic agents in a cycle
credit money: money created when banks issue loans, recorded as numbers in bank accounts and backed by the promise of repayment
wage: payment for work
invest: dedicating money, time, or effort into something with the expectation of future financial returns or a positive outcome
debt: an amount of money owed to an individual or organisation
economic growth: an increase in the total value of goods and services produced in a period of time
economic inequality: unequal distribution of income and opportunity between different groups in society
tax: payment from individuals or organisations to the government, used to provide public infrastructure and services
finance: to provide funding for a person or organisation
reserve: a form of digital money held by commercial banks at the central bank and used to settle payments between banks
reserve requirement: a rule that sets how much central bank reserve money a bank must hold relative to the loans it creates
interest rate: the price a borrower pays to borrow a sum of money
policy rate: the interest rate set by the central bank that influences borrowing costs and how much new money is created
economy: all the human-made systems that transfer and transform energy and matter to meet human needs and wants
credit guidance: when governments or central banks encourage banks to lend money toward specific public goals, such as housing or clean energy
regenerative economy: an economic system that meets human needs in a way that strengthens social and ecological systems
inflation: a rise in the general price levels of an economy over time
power: the ability to influence events or the behaviour of other people
supply chain: the sequence of processes involved in the production and distribution of a product
system: a set of interdependent parts that organise to create a functional whole
speculative finance: making money by betting on price changes in assets, rather than investing in activities that meet real human needs
extraction: taking something away from somewhere else, especially using effort or force
profit: total revenue minus total cost
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