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Mediums of exchange have been used by people for many years. As time evolved so did the creation and use of money. Different countries have their unique dominations; however, how money is created is essentially the same. Often, money is thought to be created when it is printed by a central bank or the government. This is only partially true as money can be created in two ways; it can be printed or it can be created through loans from commercial banks. With the creation of money, policies have to be implemented to monitor and control the supply. If too much money is in circulation inflation is possible, and if too little money is in circulation a recession is possible. This paper will discuss how money is created, the effects of monetary policies on the supply of money and how monetary policies affect the macroeconomic factors of the economy.
The most modern way of creating money is through loans. Commercial banks are required by the Federal Reserve to keep a required reserve that is "an amount of funds equal to a specified percentage of the bank's own deposit liabilities" (McConnell & Brue, 2002, p. 254). Once the reserve is met, banks can add extra reserves to the Federal Reserve Banks which will enable the commercial banks to lend money. When a loan is made to a customer, funds are transferred to borrowers through checkable deposits. The loan creates an asset on one side of the bank's balance sheet and a liability on the other side (the checkable deposit). As the borrower uses the new loan, the checkable deposit, to make purchases money is created because addition checkable deposits will be created in other banks.
Real-world complications can arise from this money creation model. The Federal ...