2025-11-30

Where does money come from?

Macroeconomics, Money · PLEX Lab

The short answer

In a modern economy, most money is created by commercial banks when they make loans, not by governments printing banknotes. When a bank approves a loan, it simultaneously records a new loan asset and credits the borrower’s deposit account with new money that did not exist before. Central banks create cash and reserves that support this system, set its constraints, and, through tools like quantitative easing (QE), can expand or contract the supply of central bank money.

To understand where money comes from, we need to distinguish the different forms of money, walk through how a single loan creates new deposits, and see how central bank operations sit above that process.

The forms of money in a modern economy

“Money” is not one single thing. Most countries have three core layers: physical cash, commercial bank deposits, and central bank reserves. On top of that, new digital forms (e-money, stablecoins, CBDCs) are emerging, but they still sit within or alongside this hierarchy.

Physical cash

Physical cash includes banknotes and coins issued by the central bank or government. It is a direct liability of the state and can be used by anyone to settle transactions. In most advanced economies, physical cash is a small share of what people and businesses use as money day to day.

Commercial bank deposits (the majority of money)

When you see your balance in a bank account, you are looking at a deposit: a promise by your bank to pay you cash or transfer funds on your behalf. Deposits are liabilities of commercial banks. In most modern economies, deposits make up the bulk of broad money measures such as M1 and M2.

Crucially, deposit balances are not limited by prior deposits inside that bank. They expand when banks extend new credit and contract when loans are repaid or written off.

Central bank reserves (banks-only money)

Central bank reserves are balances that commercial banks hold in their accounts at the central bank. They are used to settle large-value payments between banks and to meet regulatory requirements. Members of the public never see reserves directly; they sit entirely “behind the scenes” in the banking system.

Emerging forms: e-money, stablecoins and CBDCs

E-money issuers, payment platforms and stablecoin providers create additional layers of money-like claims. Often, these are backed by bank deposits or short-term government securities. Central banks are also exploring or piloting central bank digital currencies (CBDCs), which are digital forms of central bank money that could be held by the public. These developments change how people access money, but they still rest on the same underlying balance sheets.

Illustrative comparison of money types

Form	Issuer	Who holds it?	Typical role
Physical cash	Central bank / government	Public, firms, banks	Retail payments, small-store-of-value
Bank deposits	Commercial banks	Public and firms	Main medium of exchange & savings vehicle
Central bank reserves	Central bank	Banks only	Settlement between banks, monetary policy
E-money / stablecoins	Private issuers (often regulated)	Public and firms	Alternative payment rails, programmable money

This table is an educational example. Shares and roles vary by country and over time.

Stylised illustration of money flows between households, banks and the central bank — Conceptual view of money flowing between households, banks and the central bank. The labels change by country, but the core structure is similar.

How commercial banks create money

The simplest answer to “Where does money come from?” is: from commercial banks, when they make loans. A modern bank does not wait passively for depositors to hand over spare cash. Instead, when it approves a loan, it creates new purchasing power for the borrower by crediting a deposit account, then worries about funding and liquidity afterwards.

On the bank’s balance sheet, the new loan is an asset (a claim on the borrower), and the matching deposit is a liability (a promise to pay the borrower on demand). At the moment of creation, no one else’s deposit has been reduced; total deposits in the banking system have increased.

The bank’s balance sheet before the loan

A bank starts with existing assets (loans, securities, central bank reserves) and liabilities (customer deposits, wholesale funding, equity). The level of deposits reflects past lending and funding decisions, not a fixed pot waiting to be lent out.
The bank approves a new loan

After assessing the borrower’s creditworthiness and collateral, the bank agrees to extend a loan for, say, 100 units of currency. It records a new loan asset on its books for 100.
The bank creates a matching deposit

Simultaneously, the bank credits the borrower’s current account with a 100-unit deposit. From the customer’s perspective, new money has appeared in their account. From the bank’s perspective, it has a new liability matching the loan asset.
The borrower spends the new deposit

When the borrower pays a seller, the deposit may move to another bank. Behind the scenes, reserves move between banks to settle the payment. Individual banks’ deposits and reserves change, but the total level of deposits in the system remains higher than before the loan.
Loan repayment destroys money

As the borrower repays the loan principal, the bank reduces both the loan asset and the corresponding deposit or cash inflow. When principal is fully repaid, that part of the money originally created by the loan has been destroyed.

Myth vs reality about bank lending

Myth: banks just lend out existing deposits

A common picture is that banks are intermediaries that take deposits from savers and lend them to borrowers. In practice, modern commercial banks create new deposits when they lend. Funding and liquidity constraints still matter, but they bind after the loan decision, not before.

Reality: loans create deposits, within constraints

Banks operate under capital requirements, liquidity regulations, risk management policies and competitive pressures. These constraints limit how much credit they can safely extend, even though each new loan mechanically creates a new deposit. Central banks influence those constraints by setting interest rates and providing or withdrawing reserves.

Myth: reserves are “multiplied” into loans

Older textbooks often describe a money multiplier in which every unit of central bank reserves supports a predictable multiple of deposits. Today, central banks and many economists emphasise that causality largely runs the other way: banks create loans and deposits first, then obtain the reserves they need to settle payments and meet requirements.

How central banks create money

Central banks create and destroy central bank money: banknotes and reserves. This is the foundation on which commercial banks expand or contract the supply of deposit money. Understanding this layer is essential for interpreting policies like quantitative easing (QE) and quantitative tightening (QT).

Issuing cash and reserves

When the public withdraws cash from banks, central banks ship banknotes and debit the bank’s reserve account. When cash flows back to banks and is returned, the central bank credits reserves and reduces banknotes in circulation. Similarly, central banks can create reserves by lending to banks or purchasing assets, and destroy reserves by doing the opposite.

Modern money creation: Quantitative Easing (QE)

Under QE, a central bank purchases large quantities of government bonds or other securities, usually from banks or large investors. It pays for these assets by creating new reserves. From the seller’s perspective, they swap a bond for a deposit or reserve balance; from the central bank’s perspective, both its assets (securities) and liabilities (reserves) increase.

QE directly increases the quantity of reserves and can indirectly influence broad money by changing yields, asset prices and risk-taking incentives. However, it does not simply “drop money from helicopters”; it is an asset swap, and its effect on bank lending and deposits depends on how banks, investors and borrowers respond.

Illustrative broad money (M2) over time

M2 money supply (index)

Download chart data (CSV)

This chart is an illustrative example of a broad money index that trends upward over time with noticeable jumps during crises and large policy interventions. For real-world data, see official M2 money stock series from national central banks or statistical agencies.

How money is destroyed

Money is destroyed when the balance sheets that created it move in reverse. The most important channel is loan repayment: when a borrower repays principal, the bank reduces the loan asset and either reduces the borrower’s deposit or takes in cash and reserves. The deposit that was originally created by the loan disappears.

Money can also be destroyed when loans are written off, when QE is unwound through quantitative tightening (QT), and when governments run large surpluses that withdraw deposits from the private sector and hold the proceeds in central bank accounts.

Loan principal repayment: destroys the deposit originally created by the loan.
Loan write-offs: reduce the loan asset without a matching deposit, shrinking banks’ capital and their capacity to lend.
Quantitative tightening (QT): central banks sell assets or let them mature, absorbing reserves and deposits.
Taxation and surpluses: when governments tax more than they spend, private deposits fall and balances are moved to government and central bank accounts.

Reading monetary statistics safely

Headline charts of “money supply” can be confusing or misleading if you do not know exactly what is being measured. Different aggregates (M0, M1, M2, M3, “broad money”) include different components of cash, deposits and other short-term instruments. Units and adjustments also matter: a steep line may represent an index, not a percentage, or a nominal level, not a value relative to GDP.

Copyable checklist for reading money data

Use this checklist before drawing conclusions from any money-supply chart.

Identify the aggregate (M0, M1, M2, M3 or “broad money”) and what it includes.
Check the units and scale (currency units, billions, trillions, index level).
Confirm whether the series is seasonally adjusted and if it is nominal or real.
Note the frequency (daily, monthly, quarterly) and the start date of the series.
Compare money growth with real activity (e.g. GDP) and inflation, not in isolation.
Look for structural breaks (regime changes, new regulations, QE/QT episodes).
Read the data source documentation (central bank or statistics office footnotes).

Why where money comes from matters

Understanding where money comes from clarifies the link between banking, central banking and the real economy. It explains why credit booms and busts can have such powerful effects and why central banks focus on the resilience of banks, not just on printing notes or changing interest rates.

It also helps to ground debates about inflation, government deficits and unconventional policy. When you know that most money is created as bank credit, and that central banks mainly operate through interest rates and balance sheet operations, slogans about “money printing” become easier to interpret and, when necessary, to challenge.

For a deeper dive into how changes in money supply interact with prices, you might explore related PLEX articles on money and inflation or on how to read macroeconomic charts responsibly.

References & further reading

Bank of England — “Money creation in the modern economy”
Canonical central bank explainer on how commercial bank lending creates deposits and the role of reserves.
Bank of England — “Money in the modern economy: an introduction”
Clear overview of different types of money and their issuers, suitable as a companion to this article.
IMF — Back to Basics series on money and banking
Short, accessible explainers on what money is, how banks work and how central banking has evolved.
Federal Reserve FRED — M2 Money Stock (M2SL)
Official US time series for broad money (M2), with downloadable data and charting tools.
New Economics Foundation — “Where Does Money Come From?”
Book-length treatment of money creation in the UK, with detailed balance sheet examples and policy discussion.
Positive Money — How banks create money
Campaign-focused explanation with diagrams and myth-busting aimed at the general public.
Bank for International Settlements (BIS) — speeches and reports on money and monetary policy
Technical and policy-oriented material on bank-based money creation, QE and the evolving monetary system architecture.
Wikipedia — Money creation
Useful reference entry that summarises different theories of money creation and links to primary sources.