1Her life
Friday morning, Maya's phone buzzes: her paycheck just landed. $2,000, after taxes.
She never touches a single bill. It goes straight from her employer's bank to hers, and she'll spend most of it the same way: rent by transfer, groceries by card, a coffee by tapping her phone.
So where is that $2,000, exactly?
2How it works
Money is something people trust others will accept. It does three jobs:
- You can spend it. A way to pay.
- You can save it. A way to keep value for later.
- You can price things with it. A shared yardstick: a coffee is $5, rent is $1,400.
A dollar has no value on its own. It works because of that trust.
Most money isn't cash. In the US, bills and coins are only about a tenth of the money in the economy. Most of the rest is what Maya has: a number in a bank account. Economists call the total of all this money (cash, bank accounts and similar savings) the money supply.
Banks create most new money when they lend. When a bank approves Jordan's $20,000 car loan, it doesn't hand him someone else's savings. It adds $20,000 to his account, and that deposit is new money. When he pays the loan back, that money disappears again. The Bank of England, the UK's central bank, explained how this works in a 2014 paper.
So who decides how much money there is? Not one person with a printing press. Banks decide how much to lend, people decide how much to borrow, and the central bank (in the US, the Federal Reserve, or "the Fed") shapes both, mainly through interest rates.
3It really happened
+26.8%
In the year to February 2021, during the pandemic, as relief money flowed into bank accounts, the US money supply grew by more than 25%. That was the fastest growth on record, according to the St. Louis Fed.
First hike
The Fed raised rates for the first time since 2018. It kept going.
See it in Historical Data →9.1%
Consumer prices were up 9.1% from a year earlier, according to the Bureau of Labor Statistics: the biggest yearly rise since 1981.
See it in Historical Data →The honest part
Economists still argue about how much of that inflation (prices rising across the economy) came from the extra money and how much from other things, like snarled supply chains and energy prices. A San Francisco Fed study, for example, put about half of the rise down to supply problems. The chain above is one link in a bigger story, not the whole of it.
Sources for this chapter (8)
- FRED (St. Louis Fed): M2 money supply
- St. Louis Fed: The rise and fall of M2
- FRED (St. Louis Fed): Currency in circulation
- Bank of England: Money creation in the modern economy (2014)
- BLS: Consumer Price Index, June 2022
- Federal Reserve: statement, Mar 16, 2022
- Federal Reserve: statement, Dec 19, 2018
- San Francisco Fed: How much do supply and demand drive inflation?
Maya and Jordan are fictional; every number in "It really happened" is real and sourced. We explain how it works. What you do with it is your call. Commentary and education only. Not financial advice.