Who Controls the Money Supply? A Guide to Central Banking

The question "who controls the money supply?" does not have a simple answer. It is not the government. It is not the central bank alone. It is a distributed process involving central banks, commercial banks, regulators, and the demand for credit. Understanding how it works is essential to understanding why Bitcoin was designed the way it was.

This article is part of our What Is Money? series.

The Central Bank

The central bank (the Federal Reserve in the US, the Bank of England in the UK, the ECB in Europe) has two primary monetary functions. First, it sets the base interest rate — the cost at which commercial banks can borrow reserves. Second, it can expand or contract its own balance sheet by buying or selling assets, typically government bonds.

When the central bank buys bonds from commercial banks, it credits their reserve accounts with new reserves. These reserves did not exist before the purchase. They are created by the act of buying. This is what quantitative easing is, in technical terms: the central bank creating new reserves by purchasing assets.

Commercial Banks

Here is the part most people do not know: commercial banks create the vast majority of the money in circulation. They do this through lending.

When a bank issues a mortgage, it does not withdraw money from a vault or transfer it from another depositor's account. It creates a new deposit in the borrower's account — literally typing a number into a database — and records the loan as an asset on its own balance sheet. New money now exists that did not exist before the loan was issued.

The Bank of England confirmed this explicitly in a 2014 paper: "Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money."

When the loan is repaid, the money is destroyed. The deposit is cancelled against the loan. The money supply therefore expands with net new lending and contracts with net repayment.

What Limits the Supply?

Three constraints limit how much money commercial banks can create:

• Capital requirements — regulators require banks to maintain a ratio of capital to loans. This limits total lending but does not cap it.
• Demand for credit — banks can only create money by finding willing borrowers. If no one wants to borrow, the supply cannot expand.
• Central bank interest rates — higher rates make borrowing more expensive, reducing demand for credit and slowing money creation.

Notice what is absent: a hard ceiling. There is no fixed upper limit on the money supply. It is governed by institutional decisions and market conditions, not by any external constraint. This is the fundamental difference between fiat and hard money.

Why This Matters

The system has a structural incentive toward expansion. Low interest rates encourage borrowing. Borrowing creates money. More money in circulation drives asset prices higher. Higher asset prices make borrowers feel wealthier, encouraging more borrowing. The cycle is self-reinforcing — until it isn't.

When the expansion reverses — when credit contracts, borrowers default, and the money supply shrinks — the result is recession. The Austrian School calls this the bust phase of the credit cycle. It is not an accident. It is the inevitable consequence of the expansion. See What Is Inflation, Really? for how this plays out in prices.

Bitcoin removes every element of this system. The supply is fixed at 21 million. No lending activity creates new bitcoin. No central authority adjusts the issuance rate. The supply is determined by mathematics, enforced by code, and verified by every node on the network.

The root problem with conventional currency is all the trust that's required to make it work. — Satoshi Nakamoto