Bank of England's article on money creation states:

Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money

Now when new money gets created it obviously reduces the value of existing money: citizens' purchasing power gets reduced.

I wonder how the interest rate logic goes; currently banks for example receive 100% of the interest paid for the loans they make. But if this money is from citizens shouldn't they get their share theoretically as well?

One argument for banks taking interests to themselves could be that banks carry the risks for the money not getting paid back. However, aren't citizens carrying the risks as well because if money is not paid back it does not get destroyed (as would happen when the money is paid back) and the related purchasing power would not be restored (just like with any loans which are not paid back)?

Another supporting argument could be that the process of granting loans involves some work (e.g. studying the backgrounds of potential customers; paying salaries for employees) but shouldn't this be between the borrower and the lender? If citizens are involved in lending (by giving up their purchasing power) shouldn't they get a share?

Am I just missing something obvious?

Doesn't this make it extremely important for people to minimize the amount of currency they store e.g. in bank accounts, as opposed to for example investing it (assuming the amount of debt commercial banks create is likely to increase over time)?

1 Answer 1


By your logic, if a loan of £100 is new money dilutes your purchasing power, then the repayment of £110 is a reduction of the money supply that increases your purchasing power. Indeed, ultimately the increase in purchasing power upon repayment is greater than the initial reduction, so you are 'better off' every time a loan is made and successfully repaid.

The effect on you is tiny, but the collective benefit you get from all the loans being repaid with interest is more or less equivalent to the purchasing power reduction of the loans that are never repaid. Therefore you do not lose out and are indeed compensated (in a tiny way) for the tiny risk you incurred.

The bank incurs a substantial risk and is thus compensated in a substantial way.

  • 2
    There is a logical fallacy because the £10 interest also needs to be borrowed from banks (loans are how money enters circulation). So the £10 interest leaves us worse rather than better off. Also there is a logical fallacy in the 2nd argument: While the effect of one individual loan indeed is tiny (when distributed to all the citizens), the effect of thousands and thousands, even millions, of loans is huge. In 1900 you could buy many things with just a couple of cents, such is the effect of the loss in purchasing power. About the 3rd:How do banks incur larger risk than citizens?
    – karl1352
    Nov 30, 2017 at 12:51
  • A quick Google suggests that "total money supply" is $83 trillion dollars, so each $100 loan reduces your purchasing power by 0.00000000012% of your net worth. A bank risks losing $100, a millionaire risks losing 0.00012 cents. A million such loans only reduces the purchasing power of a millionaire by $1.2. For someone with less net worth, the difference is even more tiny. This is not a 'huge' effect by any standards. In as much as there is a small loss (and inflation does obviously exist) it is considered a reasonable penalty to hoarding capital and encouraging people to make use of it. Nov 30, 2017 at 17:12
  • $100 loans are only a drop in the ocean. All the loans combined could mean $10s, $100s or $1000s per month for a citizen. Purchasing power every single month on average. How would that not be significant? (btw how did you get to the $83 trillion estimate? US stopped publishing M3 already in 2006). Please also note please note that the same salary a citizen gets can buy less every month: it is not only about saving money in a bank account (or "hoarding" as you mentioned)
    – karl1352
    Dec 1, 2017 at 5:54

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