3.3Banks and the creation of money

For the authorities, and for most economists too, the signicance of deposit-taking

institutions lies in the fact that the deposits which they hold function as money. As

Table 3.4 shows, the current ofcial measure of broad money, M4, contains bank and

building society deposits. Furthermore, these deposits make up 96 per cent of M4. It

follows therefore that an expansion of bank and building society activity, where this

involves an expansion of deposits, automatically involves an increase in the stock of

money with the possibility that this in turn leads to an increase in aggregate demand

and in output and/or prices. In this section we want to look rstly at why banks have

Table 3.4	Monetary aggregates – denition and magnitude, 2006, end-January
Symbol	DenitionMagnitude (£bn)

M0	Notes and coin outside the Bank of England banks’	46
	operational deposits at the Bank of England

M4	Notes and coin in circulation with the non-bank, non-building	1,365
	society private sector1M4PS holdings of sterling bank sight
	deposits M4PS holdings of sterling bank time deposits and
	CDs M4PS holdings of building society deposits – building
	society holdings of bank deposits, CDs and notes and coin

¹The expression ‘M4 private sector’ is often used as a substitute for ‘non-bank, non-building society

private sector’.

Source: Bank of England, interactive database: series LPMAVAD and LPMAUYN

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3.3 Banks and the creation of money

an interest in expanding the volume of deposits and thereby the stock of money.

Secondly, we shall look at how they are able to do it. In section 3.4 we shall look at

some of the possible constraints on deposits and monetary expansion.