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All They Told You About Money Printing Is Really, Really Wrong. And here is why.


Alfonso Peccatiello of TheMacroCompass.com explains that if central bankers and their economists applied a little common sense, they would realise that their decisions are based on mistakes.

We assume we know all about money: universities and mainstream media teach us that governments need money to fund their spending, Central Banks have the authority to print money we use, and commercial banks lend and multiply customers’ money in a fractional reserve banking system.

That’s literally all wrong.

Our monetary and credit system envisages two distinct tiers of money: real-economy money (potentially inflationary) and financial-sector money (potentially asset-price inflationary).

Governments and commercial banks have the ability to print real-economy money. Central Banks have the ability to only print financial-sector money.

Let me explain.

Real-economy money is the one used by non-financial private sector agents (e.g. households, corporates) to make transactions that contribute to economic activity.

The more real-economy money out there, ceteris paribus the more likely economic growth will be stronger.
Also, a rapid increase in real-economy money at a time when the supply of goods and services can’t keep up will most likely generate strong inflationary pressures.

Financial-sector money is the one used by financial entities: mostly banks, but also pension funds, asset managers and so on.

The more financial-sector money out there, the more likely financial agents will be over time to engage in riskier activities and to chase riskier assets in an attempt to generate better returns.

Banks and governments print real-economy money. Not the Central Bank!

Every time commercial banks make a loan, new real-economy money is created. Banks don't lend reserves or existing deposits: as the Bank of England itself shows, when making new loans banks expand their balance sheet and literally credit your account out of nowhere.

By doing so, they create new deposits for the non-financial private sector (e.g. people).

Now, the other real-economy money printer is the government: come again?

If the government spends more than it plans to collect taxes for (deficits), in most cases new real-economy money has been created. Government deficit spending increases the net worth of the private sector…without adding a liability to it!

The diagram below shows what happens to the balance sheet of governments, Central Banks, commercial banks and the private sector when governments run deficits.

Deficit spending increases the amount of non-financial private sector deposits (i.e. real-economy money) as long as households don’t need to purchase the Treasuries issued by the government itself - which in most cases are anyway bought by financial institutions or the Central Bank.

This means deficit spending prints real-economy money and it increases the net worth of the private sector as households don’t experience an increase in debt.

Content and graphic copyright 2022 Alfonso Peccatiello

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