Money supply: what it is and who creates it

Money supply isn't just notes and coins. It's the whole stock of money-like claims that households and businesses hold — and in a modern economy that's overwhelmingly deposits at banks, credit unions and building societies, not physical cash.

The catch is that "money" is a matter of degree. The cash in your pocket and the balance in your everyday account are instantly spendable. A three-year term deposit is clearly worth money, but you can't use it to buy a coffee today. Because different kinds of money are spendable to different extents, the Reserve Bank doesn't report a single figure — it publishes a range of measures that widen step by step, from the most spendable to the least.

There are five in all: currency, the money base, M1, M3 and broad money. Most "money supply" commentary means one of the broader ones — usually M3 or broad money.

The measures nest inside one another like Russian dolls — each wider one contains everything in the narrower ones, then adds a layer.

Currency is the narrowest: banknotes and coins in the public's hands. M1 adds the money you can spend on demand — currency plus transaction (at-call) accounts at banks, credit unions and building societies. M3 widens it to include the rest of those institutions' deposits — savings and term deposits — plus certificates of deposit they issue. Broad money is the widest measure in common use: M3 plus other short-term liquid liabilities of financial institutions, such as short-term debt securities.

Each step trades a little spendability for a fuller picture of the money sloshing around the system. The builder below lets you stack the layers yourself.

Here's the part that surprises most people: the bulk of money isn't printed by the Reserve Bank. When a bank makes a loan, it doesn't quietly hand over someone else's savings — it credits the borrower's account with a brand-new deposit. That deposit is money. So most of the money supply is created by commercial banks through lending, and it shrinks again as loans are repaid.

The Reserve Bank's role is more indirect than the "printing money" image suggests. It issues the physical cash, and it supplies the money base — currency in circulation plus the deposits banks hold at the RBA. Above all it sets the cash rate, the interest rate on overnight loans between banks, which ripples out to the cost of all the borrowing that creates deposits in the first place. It steers the system; it doesn't manufacture most of the money in it.

If money is created and destroyed by lending, why watch it at all? Because big swings can be a useful signal. Rapid growth in the money supply often goes hand in hand with strong borrowing and spending; a sharp slowdown can flag that credit is tightening. It's one window onto the financial weather.

There's also a long-standing idea — the quantity theory of money — that more money chasing the same goods pushes prices up, which links money growth to inflation. But the link is loose and slow, not mechanical. How fast money actually gets spent (its "velocity") shifts over time, and where new money flows matters as much as how much there is: money that pours into asset prices like housing doesn't show up in everyday inflation the same way money spent at the shops does. Treat money-supply figures as one indicator among many, not a dial that sets the cost of living.