[{"data":1,"prerenderedAt":764},["ShallowReactive",2],{"article:\u002Farticles\u002Fhow-money-and-banks-work":3},{"article":4,"related":749},{"id":5,"title":6,"author":7,"body":8,"category":735,"description":736,"extension":737,"kind":738,"meta":739,"navigation":740,"path":741,"publishedAt":742,"readingTime":743,"reviewer":744,"seo":745,"stem":746,"trending":747,"updatedAt":742,"__hash__":748},"articles\u002Farticles\u002Fhow-money-and-banks-work.md","How Money and Banks Work","Lynktor Editorial Team",{"type":9,"value":10,"toc":717},"minimark",[11,16,25,28,50,53,57,68,75,79,86,89,104,107,113,117,120,123,128,135,227,230,539,543,546,570,574,581,607,611,641,650,654,660,663,677,680,684,696,700],[12,13,15],"h2",{"id":14},"what-money-is-for","What money is for",[17,18,19,20,24],"p",{},"Imagine an economy without money. A baker who wants shoes has to find a shoemaker who wants bread, at the same moment, in matching quantities. Economists call this the problem of the ",[21,22,23],"strong",{},"double coincidence of wants",", and it makes trade slow and costly. Money solves it.",[17,26,27],{},"Money is defined by what it does. It has three functions:",[29,30,31,38,44],"ol",{},[32,33,34,37],"li",{},[21,35,36],{},"Medium of exchange."," It is widely accepted in payment for goods and services, so you can sell your labor for money and spend the money on anything.",[32,39,40,43],{},[21,41,42],{},"Unit of account."," Prices, wages, and debts are all measured in it, which makes comparison easy.",[32,45,46,49],{},[21,47,48],{},"Store of value."," It holds its value well enough to be saved and spent later. (Inflation weakens this function, which is one reason central banks try to keep inflation low.)",[17,51,52],{},"Over history, many things have served as money: shells, salt, cattle, gold, and silver. A good money is durable, portable, divisible, uniform, and hard to counterfeit.",[12,54,56],{"id":55},"from-commodity-money-to-fiat-money","From commodity money to fiat money",[17,58,59,60,63,64,67],{},"Early money was ",[21,61,62],{},"commodity money",": it had value in itself, like gold coins. Later came ",[21,65,66],{},"representative money",": paper notes that could be exchanged for a fixed amount of gold or silver. Under the gold standard, a country's money supply was tied to its gold reserves.",[17,69,70,71,74],{},"Today's money is ",[21,72,73],{},"fiat money",". A dollar bill is not backed by gold; it is valuable because the government declares it legal tender, requires taxes to be paid in it, and because people trust that others will accept it. The United States ended the last link between the dollar and gold in 1971. Fiat money gives central banks the flexibility to respond to crises, but it relies on their credibility to avoid creating too much.",[12,76,78],{"id":77},"most-money-is-bank-deposits","Most money is bank deposits",[17,80,81,82,85],{},"When people think of money they picture cash, but cash is a small share of the money in a modern economy. Most money is ",[21,83,84],{},"bank deposits",": the balances in checking and savings accounts that you spend with a card or a transfer.",[17,87,88],{},"Economists measure the money supply at different levels:",[90,91,92,98],"ul",{},[32,93,94,97],{},[21,95,96],{},"M1"," includes currency held by the public and deposits that can be spent easily, such as checking accounts and, in the U.S. since 2020, savings accounts.",[32,99,100,103],{},[21,101,102],{},"M2"," adds less liquid forms such as small time deposits (certificates of deposit) and retail money market funds.",[17,105,106],{},"The exact definitions vary by country and change over time, but the pattern is the same everywhere: deposits dominate.",[108,109,110],"pull-quote",{},[17,111,112],{},"When a bank makes a loan, it does not hand out someone else's savings. It creates a new deposit.",[12,114,116],{"id":115},"how-banks-create-money","How banks create money",[17,118,119],{},"A bank's basic business is to take deposits and make loans, earning the difference between the interest it charges borrowers and the interest it pays depositors. The surprising part is what lending does to the money supply.",[17,121,122],{},"When a bank approves a $10,000 car loan, it does not take $10,000 out of other customers' accounts. It credits the borrower's account with a new $10,000 deposit. The borrower pays the car dealer, whose account (at the same bank or another) goes up by $10,000. That deposit did not exist before: lending has created new money. When the loan is repaid, the money disappears again.",[124,125,127],"h3",{"id":126},"the-textbook-money-multiplier","The textbook money multiplier",[17,129,130,131,134],{},"Traditional textbooks explain this process with ",[21,132,133],{},"reserve requirements",". Suppose banks must keep 10% of deposits as reserves and lend out the rest. A new $1,000 deposit allows a $900 loan, which becomes a $900 deposit somewhere else, which allows an $810 loan, and so on:",[136,137,138,157],"table",{},[139,140,141],"thead",{},[142,143,144,148,151,154],"tr",{},[145,146,147],"th",{},"Round",[145,149,150],{},"New deposit",[145,152,153],{},"Kept as reserves (10%)",[145,155,156],{},"Lent out",[158,159,160,175,188,201,214],"tbody",{},[142,161,162,166,169,172],{},[163,164,165],"td",{},"1",[163,167,168],{},"$1,000.00",[163,170,171],{},"$100.00",[163,173,174],{},"$900.00",[142,176,177,180,182,185],{},[163,178,179],{},"2",[163,181,174],{},[163,183,184],{},"$90.00",[163,186,187],{},"$810.00",[142,189,190,193,195,198],{},[163,191,192],{},"3",[163,194,187],{},[163,196,197],{},"$81.00",[163,199,200],{},"$729.00",[142,202,203,206,208,211],{},[163,204,205],{},"4",[163,207,200],{},[163,209,210],{},"$72.90",[163,212,213],{},"$656.10",[142,215,216,219,221,224],{},[163,217,218],{},"5",[163,220,213],{},[163,222,223],{},"$65.61",[163,225,226],{},"$590.49",[17,228,229],{},"After five rounds, total deposits reach about $4,095. If the process continued forever, they would approach:",[231,232,235],"span",{"className":233},[234],"katex-display",[231,236,239,292],{"className":237},[238],"katex",[231,240,243],{"className":241},[242],"katex-mathml",[244,245,248],"math",{"xmlns":246,"display":247},"http:\u002F\u002Fwww.w3.org\u002F1998\u002FMath\u002FMathML","block",[249,250,251,287],"semantics",{},[252,253,254,258,262,271,273,282,284],"mrow",{},[255,256,257],"mtext",{},"Maximum deposits",[259,260,261],"mo",{},"=",[263,264,265,268],"mfrac",{},[255,266,267],{},"Initial deposit",[255,269,270],{},"Reserve ratio",[259,272,261],{},[263,274,275,279],{},[276,277,278],"mn",{},"1,000",[276,280,281],{},"0.10",[259,283,261],{},[276,285,286],{},"10,000",[288,289,291],"annotation",{"encoding":290},"application\u002Fx-tex","\\text{Maximum deposits} = \\frac{\\text{Initial deposit}}{\\text{Reserve ratio}} = \\frac{1{,}000}{0.10} = 10{,}000",[231,293,297,326,428,519],{"className":294,"ariaHidden":296},[295],"katex-html","true",[231,298,301,306,314,319,323],{"className":299},[300],"base",[231,302],{"className":303,"style":305},[304],"strut","height:0.8889em;vertical-align:-0.1944em;",[231,307,311],{"className":308},[309,310],"mord","text",[231,312,257],{"className":313},[309],[231,315],{"className":316,"style":318},[317],"mspace","margin-right:0.2778em;",[231,320,261],{"className":321},[322],"mrel",[231,324],{"className":325,"style":318},[317],[231,327,329,333,419,422,425],{"className":328},[300],[231,330],{"className":331,"style":332},[304],"height:2.0574em;vertical-align:-0.686em;",[231,334,336,341,415],{"className":335},[309],[231,337],{"className":338},[339,340],"mopen","nulldelimiter",[231,342,344],{"className":343},[263],[231,345,349,406],{"className":346},[347,348],"vlist-t","vlist-t2",[231,350,353,401],{"className":351},[352],"vlist-r",[231,354,358,375,386],{"className":355,"style":357},[356],"vlist","height:1.3714em;",[231,359,361,366],{"style":360},"top:-2.314em;",[231,362],{"className":363,"style":365},[364],"pstrut","height:3em;",[231,367,369],{"className":368},[309],[231,370,372],{"className":371},[309,310],[231,373,270],{"className":374},[309],[231,376,378,381],{"style":377},"top:-3.23em;",[231,379],{"className":380,"style":365},[364],[231,382],{"className":383,"style":385},[384],"frac-line","border-bottom-width:0.04em;",[231,387,389,392],{"style":388},"top:-3.677em;",[231,390],{"className":391,"style":365},[364],[231,393,395],{"className":394},[309],[231,396,398],{"className":397},[309,310],[231,399,267],{"className":400},[309],[231,402,405],{"className":403},[404],"vlist-s","​",[231,407,409],{"className":408},[352],[231,410,413],{"className":411,"style":412},[356],"height:0.686em;",[231,414],{},[231,416],{"className":417},[418,340],"mclose",[231,420],{"className":421,"style":318},[317],[231,423,261],{"className":424},[322],[231,426],{"className":427,"style":318},[317],[231,429,431,435,510,513,516],{"className":430},[300],[231,432],{"className":433,"style":434},[304],"height:2.0074em;vertical-align:-0.686em;",[231,436,438,441,507],{"className":437},[309],[231,439],{"className":440},[339,340],[231,442,444],{"className":443},[263],[231,445,447,499],{"className":446},[347,348],[231,448,450,496],{"className":449},[352],[231,451,454,465,473],{"className":452,"style":453},[356],"height:1.3214em;",[231,455,456,459],{"style":360},[231,457],{"className":458,"style":365},[364],[231,460,462],{"className":461},[309],[231,463,281],{"className":464},[309],[231,466,467,470],{"style":377},[231,468],{"className":469,"style":365},[364],[231,471],{"className":472,"style":385},[384],[231,474,475,478],{"style":388},[231,476],{"className":477,"style":365},[364],[231,479,481,484,492],{"className":480},[309],[231,482,165],{"className":483},[309],[231,485,487],{"className":486},[309],[231,488,491],{"className":489},[490],"mpunct",",",[231,493,495],{"className":494},[309],"000",[231,497,405],{"className":498},[404],[231,500,502],{"className":501},[352],[231,503,505],{"className":504,"style":412},[356],[231,506],{},[231,508],{"className":509},[418,340],[231,511],{"className":512,"style":318},[317],[231,514,261],{"className":515},[322],[231,517],{"className":518,"style":318},[317],[231,520,522,526,530,536],{"className":521},[300],[231,523],{"className":524,"style":525},[304],"height:0.8389em;vertical-align:-0.1944em;",[231,527,529],{"className":528},[309],"10",[231,531,533],{"className":532},[309],[231,534,491],{"className":535},[490],[231,537,495],{"className":538},[309],[124,540,542],{"id":541},"how-it-works-in-practice","How it works in practice",[17,544,545],{},"The multiplier story captures a real idea, that bank lending expands the money supply, but modern banking works somewhat differently:",[90,547,548,554,560],{},[32,549,550,553],{},[21,551,552],{},"Lending comes first."," Banks lend when they find creditworthy borrowers and profitable opportunities, then obtain the reserves they need. They are not waiting for deposits to arrive.",[32,555,556,559],{},[21,557,558],{},"Reserve requirements matter less."," The Federal Reserve reduced U.S. reserve requirements to zero in March 2020. Many other countries have low or no requirements.",[32,561,562,565,566,569],{},[21,563,564],{},"The real constraints"," are profitability, the demand for loans, the bank's capital, and regulation. Banks must hold enough ",[21,567,568],{},"capital"," (their owners' own money) to absorb losses, and enough liquid assets to meet withdrawals.",[12,571,573],{"id":572},"central-banks-the-bank-for-banks","Central banks: the bank for banks",[17,575,576,577,580],{},"A ",[21,578,579],{},"central bank",", such as the Federal Reserve in the United States, the European Central Bank, or the Bank of England, sits at the top of the system. It does several jobs:",[90,582,583,589,595,601],{},[32,584,585,588],{},[21,586,587],{},"Issues currency"," and manages the reserves that commercial banks hold with it.",[32,590,591,594],{},[21,592,593],{},"Sets monetary policy",", mainly by steering short-term interest rates, which influences how much banks lend and how much people borrow and spend.",[32,596,597,600],{},[21,598,599],{},"Acts as lender of last resort",", lending to sound banks that face a sudden shortage of cash, to stop panics from spreading.",[32,602,603,606],{},[21,604,605],{},"Supervises banks"," and works to keep the financial system stable.",[124,608,610],{"id":609},"the-main-tools","The main tools",[90,612,613,619,625,635],{},[32,614,615,618],{},[21,616,617],{},"The policy rate."," In the U.S., the Fed sets a target range for the federal funds rate, the rate banks charge each other for overnight loans. It steers market rates into that range mainly by setting the interest it pays on banks' reserve balances.",[32,620,621,624],{},[21,622,623],{},"Open market operations."," Buying and selling government bonds to manage the amount of reserves in the system.",[32,626,627,630,631,634],{},[21,628,629],{},"Quantitative easing (QE)."," In deep downturns, when short-term rates are already near zero, central banks have bought large amounts of longer-term bonds to push down long-term interest rates. Reversing this is called ",[21,632,633],{},"quantitative tightening",".",[32,636,637,640],{},[21,638,639],{},"Forward guidance."," Communicating the likely future path of policy, which itself moves markets.",[17,642,643,644,649],{},"The ",[645,646,648],"a",{"href":647},"\u002Farticles\u002Fwhat-the-fed-does-with-interest-rates","Federal Reserve article"," explains how these decisions reach mortgages, savings accounts, and stocks.",[12,651,653],{"id":652},"why-bank-runs-happen","Why bank runs happen",[17,655,656,657,634],{},"Banks keep only a fraction of deposits as cash and reserves; the rest is lent out or invested in assets like bonds that cannot be sold instantly without risk of loss. This works because depositors rarely all want their money at once. But if people start to fear a bank is in trouble, it can become rational for everyone to withdraw at once, and the rush itself can bring the bank down, even if it was fundamentally sound. This is a ",[21,658,659],{},"bank run",[17,661,662],{},"Runs were common before modern safeguards. Today, two protections reduce the risk:",[90,664,665,671],{},[32,666,667,670],{},[21,668,669],{},"Deposit insurance."," In the United States, the FDIC insures deposits up to $250,000 per depositor, per insured bank, for each account ownership category. Insured depositors have little reason to run.",[32,672,673,676],{},[21,674,675],{},"The lender of last resort."," The central bank can lend to banks against good collateral during a panic.",[17,678,679],{},"Runs can still happen when large, uninsured deposits flee quickly, as the failure of Silicon Valley Bank showed in March 2023, when depositors withdrew tens of billions of dollars in a single day.",[12,681,683],{"id":682},"money-beyond-banks","Money beyond banks",[17,685,686,687,691,692,695],{},"New forms of money-like assets keep appearing. ",[645,688,690],{"href":689},"\u002Farticles\u002Fstablecoins-explained","Stablecoins"," aim to track the dollar using reserves held by private issuers. Many central banks are studying ",[21,693,694],{},"central bank digital currencies",", digital cash issued directly by the central bank. Each raises the same old questions: who backs it, how safe it is in a panic, and who supervises it.",[12,697,699],{"id":698},"key-ideas-to-remember","Key ideas to remember",[90,701,702,705,708,711,714],{},[32,703,704],{},"Money is anything widely used as a medium of exchange, unit of account, and store of value.",[32,706,707],{},"Modern money is fiat money, valuable because of trust and legal status, not gold backing.",[32,709,710],{},"Most money is bank deposits, and banks create new deposits when they lend.",[32,712,713],{},"Central banks steer interest rates, provide emergency liquidity, and supervise the system.",[32,715,716],{},"Bank runs are self-fulfilling panics; deposit insurance and the lender of last resort make them rarer.",{"title":718,"searchDepth":719,"depth":719,"links":720},"",2,[721,722,723,724,729,732,733,734],{"id":14,"depth":719,"text":15},{"id":55,"depth":719,"text":56},{"id":77,"depth":719,"text":78},{"id":115,"depth":719,"text":116,"children":725},[726,728],{"id":126,"depth":727,"text":127},3,{"id":541,"depth":727,"text":542},{"id":572,"depth":719,"text":573,"children":730},[731],{"id":609,"depth":727,"text":610},{"id":652,"depth":719,"text":653},{"id":682,"depth":719,"text":683},{"id":698,"depth":719,"text":699},"economy","What makes something money, how banks create most of it when they lend, what central banks control, and why bank runs happen.","md","guide",{},true,"\u002Farticles\u002Fhow-money-and-banks-work","2026-10-29",6,"Lynktor Research Desk",{"title":6,"description":736},"articles\u002Fhow-money-and-banks-work",false,"Rww2KxACCK0er9gRH4inf8dRSckRVwl8P78IXexVESM",[750,754,759],{"title":751,"description":752,"path":753,"category":735,"readingTime":743},"Fiscal Policy and Government Debt, Explained","How governments tax, spend, and borrow; the difference between deficits and debt; when stimulus works; and when debt becomes a problem.","\u002Farticles\u002Ffiscal-policy-and-government-debt",{"title":755,"description":756,"path":757,"category":735,"readingTime":758},"GDP and the Business Cycle: How Economies Grow and Shrink","What gross domestic product measures, how it is calculated three ways, why real GDP matters more than nominal, and how expansions and recessions unfold.","\u002Farticles\u002Fgdp-and-the-business-cycle",7,{"title":760,"description":761,"path":762,"category":735,"readingTime":763},"Inflation Explained: Causes, Measurement, and Effects","What inflation really is, how it is measured, why it happens, who wins and loses, and how central banks try to keep it in check.","\u002Farticles\u002Finflation-explained",8,1793277327961]