How does the economy “grow”? Where does the new money comes from?
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The amount of money in the economy is constantly changing.
I find it easiest to understand with a quick history lesson.
Going back to the late 1800s. America (and most of the rest of the world) was on a gold standard with a private fractional reserve banking system.
This first means that the dollar was defined as a set amount of gold, e.g 1 dollar is .25 oz of gold. Not saying that the gold was worth a dollar. THE GOLD WAS THE DOLLAR. So how ever much gold was in the economy was, by definition, the amount of money in the system.
But this process was made more complicated by the fractional reserve banking system. Banks stored deposits of gold and released their own bank notes. This was what paper money was. A 1 dollar bank note was worth a dollar of gold.
But there wasn’t a one-to-one relationship between the gold and the bank notes. A bank could lend out more dollars in notes than it actually had in gold. Typically it only had to have .20 in reserve. That means it could lend $5 in notes for every $1 in reserve. Or it didn’t have to lend any at all.
This brings up the first philosophical question. Which was the real money? The gold was legally defined as the dollar, but the bank notes were what people used. The amount of gold in the economy was roughly a constant, but the amount of notes could be anywhere between 0 and 5x the gold.
For practical purposes it’s the note. It was possible for a gold minor to bring in some gold and get bank notes. The vast majority of bank notes entered circulation through borrowing. People/business/government borrowed notes into circulation. The amount of notes in circulation could be nothing or could be multiples of the gold dollars. The amount was constantly changing.
….Skip a bunch of history…..
The federal reserve was established.
….Skip a bunch of history….
We went off the gold standard.
Today instead of bank reserves being gold, banks get reserves buy borrowing them from the central bank. Banks don’t print there own notes; instead everybody uses the federal reserve bank notes (dollars). As others have mentioned at the base of this is the national debt.
This brings the next philosophical question. Is money the national debt, the bank notes the Fed has released, the reserves the Fed has loaned to banks, or is it the numbers in our bank accounts.
Again in practice it is the numbers in our bank accounts, and like old times bank notes they are created through the lending process. So the total amount of money in circulation is equal to the amount borrowed from banks.
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