Start here · after step 5 · about 10 minutes
Pause: connect the first five ideas
You have now met five ideas from five different angles. This short exercise asks you to put them together in your own words. There is no score and nothing is sent anywhere. Try each question before you open the answer.
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An IOU from your bank to you: the bank owes you $2,000
Yes. A bank deposit is the bank's promise to pay you, on demand, in cash or by transfer. It is an asset for you and a liability for the bank.
2A bank approves a $500,000 home loan and pays it into the buyer's account. By how much has the total of bank deposits in the economy increased at that moment?
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Answer: $500,000
$500,000. The Bank of England video's central point: when a bank lends, it creates a new deposit in the borrower's account. Nobody else's deposit went down. When the loan is repaid, the deposit is destroyed again.
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Kelton argues the order is the reverse for a currency issuer: the currency must be spent into existence before it can be paid back in tax. Mainstream economists agree the government cannot run out of its own currency, but stress other limits
Good. This keeps the argument (Kelton's account of the order of operations) separate from what both sides accept: a currency issuer cannot run out of its own money, but can still face inflation and other limits.
4In four or five sentences, explain to a friend where Australian dollars come from and how they get into people's bank accounts.
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Most of the money people use is bank deposits, and banks create new deposits when they make loans; repaying loans destroys them. The Reserve Bank creates the cash in our wallets and the settlement balances banks use to pay each other. When the federal government spends, it adds money to people's bank accounts, and when we pay tax it takes money out. MMT economists, like Kelton, argue that because the government issues the currency it spends first and taxes afterwards, and that taxes are what make people want the currency. Either way, the government cannot run out of Australian dollars; the question is whether there are enough workers and resources for what it wants to do.
A strong answer
- Says that most money is bank deposits, created when banks lend
- Mentions the Reserve Bank's role in cash and settlement balances
- Explains that government spending adds to bank accounts and tax removes money
- Labels the 'taxes drive money' and 'spend first' points as Kelton's or MMT's argument
- Notes that real resources and inflation, not money, are the limit
The five ideas in one paragraph. Money is a set of IOUs: banknotes are owed by the central bank, deposits by commercial banks. Anthropologists have found little evidence that money began as a replacement for barter, though how it did begin is still debated. Banks create most of it when they lend. A government that issues its own currency adds money to the economy when it spends and removes it when it taxes, so its deficit is, to the dollar, someone else's surplus: that part is accounting. Separately, MMT economists like Kelton argue that taxes are what give the currency its value: that part is theory. The next lesson asks the obvious question: if money isn't what limits a currency issuer, what is?