banque

économie
monnaie
comprendre
stabilité

euro
connaître
l’éco en bref Who creates money?
Key facts A brief history
1600-1046 BC: traces have been found of the use of cowrie shells
Money is made up of: as a pre-monetary currency, under the Shang dynasty in China.

• coins, produced by France’s mint, the Monnaie 6th and 5th centuries BC: first coin minted in Lydia.
This currency was dokima, meaning that it had legal tender status
de Paris;
in the kingdom.

• b anknotes or fiduciary money, manufactured 335-333 BC: Aristotle theorised the three characteristics of
money for the first time, as a store of value, a unit of account and
by the Banque de France;
a medium of exchange.

• and entries in bank accounts: the bulk of money 1024: under the Song dynasty, the Chinese administration gave
is scriptural. legal tender status to the jiaozi, one of the first forms of banknote,
which had already appeared unofficially in the 9th century.
Money is mainly created at the initiative of economic 1360: Jean “the Good”, King of France, who had been taken
agents when they take out a loan to finance their prisoner by the English, was freed in exchange for a ransom. To pay
it, he created a new gold currency: the “franc à cheval”. The new
activities. When a commercial bank grants a loan to
currency gradually became the only one to circulate in the whole of
an individual or a firm, for example, the amount of the kingdom. This was the birth of the franc.
the loan extended is entered in the customer’s bank
account: the money has been created. It is said that 1742: English bankers could no longer issue banknotes as the
Bank of England now had a monopoly on banknote issuance; they
“loans make deposits”. This money can then be
therefore invented a new means of payment: the cheque.
converted into fiduciary money by the withdrawal
of cash, or give rise to cheques being written or 1848: introduction of legal tender status for banknotes in France.
transfers being made, for example. Subsequently, 1974: invention of the chip bank card.
the money that has been created in this way by 1 January 2002: changeover to the cash euro.
commercial banks continues to circulate between
agents.

What is the central bank’s role in this process?

Key figures
The central bank manufactures fiduciary money 90% 50%
and has a monopoly on the issuance of legal The proportion of scriptural money The proportion of payments by bank card
tender currency; it also steers the money creation in total currency in circulation in France in 2015
in the euro area
process by setting the price of money. By means
of key interest rates, the rates at which commercial
banks can borrow from the central bank (see “What
is monetary policy?”), it influences the interest rates
on loans to firms and individuals in the economy
as a whole. By encouraging economic agents to
apply for more or less lending from their banks,
changes in key interest rates influence the quantity
of money created.

To meet the financing requirements of the economy, 715 2.8

growth in money creation needs to vary in line with billion euro billion euro
the growth in goods and services: it should be Total amount of lending Number of euro banknotes
neither too much nor too little. This is one of the obtained by firms in France produced by the Banque de France
at end-January 2016, in 2015
main tasks of central banks. a 3% increase year-on-year

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 Breakdown of means of payment in France,
Understanding money creation by volume
(in %)
The theoretical debate 1 <1
about money creation 13

While it is now generally agreed that “loans make 18

deposits” (it is the banking system that initiates 50
money creation), the opposite was argued until
the 1970s by many economists who espoused
the fractional reserve theory. According to this 18
theory, the deposits of some bank customers are Card payments Cheques
a prerequisite for any lending to be granted to Direct debits Electronic money
other customers. In other words, deposits always Transfers Others

precede loans. Source: Banque de France, based on data from the Comité
consultatif du secteur financier (CCSF - Advisory Committee
on the Financial Sector).
This theory, which in the past held true for some
banks, no longer corresponds to the reality. By a
simple bank account entry, a loan immediately
becomes a deposit, and this accounting entry Money in circulation
expands the money in circulation in the economy. (in EUR billions)
Economic agents’ need for financing is the
12,000
source of money creation; the latter thus supports
economic activity. Loans are therefore the direct 10,000 626
source of deposits, and not the other way round.
8,000

There are, however, limits 6,000

on money creation 9,959 9,959
4,000
Commercial banks cannot extend unlimited lending
2,000
and thereby create unlimited money. There are two
types of limit on money creation: the price stability 0 1,034 1,034 1,034
Banknotes and Banknotes and coins Banknotes and coins
objective of monetary policy that leads the central coins in circulation + scriptural money + scriptural money
bank to indirectly regulate the quantity of money in + money market
instruments
circulation in the economy; and banking regulation,
Source: ECB.
which lays down prudential rules:

•  Commercial banks must hold a minimum

amount in their account with the central bank Money and you
that is proportional to their customers’ deposits Money has three functions:
in their accounts.
•  It is a unit of account, a yardstick used to post
prices and record debts. It is a unit of measurement
•  The amount of their own funds (capital, reserves,
of value in the economy.
etc.) must be proportional to the risks on the
loans granted. Money creation through lending •  It is also a medium of exchange. Money is the
therefore goes hand-in-hand with increased capital most liquid asset available in the economy.
requirements for banks.
•  Lastly, it is a store of value, something that can be
used to transfer purchasing power from the present
•  Banks must put in place internal control procedures
to the future. It serves to preserve purchasing power
in order to assess the ability of borrowers to repay
between the moment revenue is received and the
their loans and thereby reduce payment default risk.
time when it is spent.
In addition to these regulatory safeguards, banks Money is thus at the heart of our economic system
have their own internal requirements. They and occupies a central place in our daily lives. It is
themselves limit their capacity for money creation so therefore crucial that all the users of a currency have
as not to take excessive risks in lending to insolvent total confidence in its lasting value and ability to act
customers who are unable to repay their debts. as a means of exchange. This is the responsibility
of the government and the central bank: the former
can legislate, while the latter establishes its credibility
over time through the effectiveness it demonstrates
in achieving the objectives assigned to it.

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 A simplified accounting diagram: money creation and putting banknotes into circulation

Let us take an economy composed of a single commercial bank, Bank 1, and a central bank that has a monopoly
on issuing banknotes. Bank 1 has an account with the central bank.

•  Step 1: individual X borrows EUR 10,000 from Bank 1. By means of a simple accounting entry, X’s deposit
account at Bank 1 is credited with EUR 10,000.

Bank 1

Loan to X X’s deposit account

10,000 10,000

•  Step 2: customer X withdraws EUR 1,000 in banknotes. For this to happen, Bank 1 has to buy these banknotes
from the central bank. Its account at the central bank is debited by EUR 1,000 in exchange for the banknotes, which
it can now deliver to its customer X.

Central bank Bank 1

Bank 1’s deposit account Loan to X X’s deposit account

10,000 9,000
-1,000
Central bank account
Banknotes in circulation
-1,000
+1,000

Customer X: EUR 1,000 in banknotes

To learn more

Suggested viewing: Useful links:

➜  Money creation ➜ The dangers linked to the emergence of virtual currencies:
the example of bitcoins

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