How money works, in pictures
Ten simple steps, from where money comes from to what it means for your savings and mortgage. No jargon, no maths degree needed.
What is money?
Money is anything people trust to pay for things, to measure prices (a pound is a ruler for value) and to save for later. Today almost all of it is just numbers in bank accounts. Notes and coins are a small slice.
The Bank of England's 2014 paper Money creation in the modern economy found that bank deposits made up about 97% of the money in circulation at the time, with notes and coins only about 3%.
Banks create most money when they lend
When a bank gives you a loan, it doesn't hand over someone else's savings. It simply types new money into your account. The loan is the bank's asset and your new deposit is new money. In the Bank of England's words, whenever a bank makes a loan, it simultaneously creates a matching deposit
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When you repay a loan, that money disappears again. Banks can't create money without limit: they're held back by how many people want to borrow, by rules on safety, and by interest rates.
The Bank of England and Bank Rate
The Bank of England is the UK's central bank. Its Monetary Policy Committee (MPC) sets Bank Rate, the interest rate it pays banks on the money they hold with it. Bank Rate influences what banks charge for loans and pay on savings.
Bank Rate is 3.75%, as at 9 October 2026, and has been since 18 December 2025.
How the government spends and borrows
The government pays for schools, hospitals and pensions with taxes. When it spends more than it collects, it borrows by selling gilts: IOUs that pay interest and repay £100 at the end. The Debt Management Office (DMO) sells them for the Treasury.
Buyers include pension funds and insurers (who need steady, long-term income), banks, overseas investors and, during quantitative easing, the Bank of England. The DMO's data shows about £2.94 trillion of gilts in issue (nominal, including inflation uplift on index-linked gilts) at close of business on 9 October 2026.
QE and QT, explained
Quantitative easing (QE): when cutting Bank Rate wasn't enough, the Bank of England created new money (central bank reserves) and used it to buy gilts and some corporate bonds. That pushed down long-term interest rates to support spending. The total reached £895 billion (£875 billion of gilts and £20 billion of corporate bonds) by the end of 2021, held in the Asset Purchase Facility (APF).
Quantitative tightening (QT) is the reverse: since 2022 the Bank has been letting gilts mature and selling some. By September 2026 the APF had fallen to around £488 billion. The MPC plans to unwind the remaining gilts held for monetary policy by the end of 2034, while £120 billion of the longest-dated gilts will be kept to back banknotes.
The money supply grows
Each new loan adds money, and each repayment removes it. When people and businesses borrow more than they repay, the total amount of money in the economy (the "money supply") grows. QE adds money too, and QT takes some out. If money grows much faster than the goods and services there are to buy, prices tend to rise.
Inflation and the 2% target
Inflation is how fast prices rise on average. The ONS measures it with the Consumer Prices Index (CPI). The government has set the Bank of England a target of 2% CPI inflation.
The latest figure is 3.1% for 2026 Aug. The highest monthly rate in the series was 11.1% in 2022 Oct. The calendar-year average peaked at 9.1% in 2022.
What inflation does to cash
If prices rise faster than the interest on your savings, your money buys less each year, even though the number in your account stays the same or goes up. That's the real value of your money. Try it:
Interest rates are the brake
When inflation runs above target, the Bank of England can raise Bank Rate. Borrowing gets more expensive and saving pays more, so people and businesses spend a bit less and price rises slow. When inflation is low and the economy is weak, it can cut rates to encourage spending. Changes take time to work – often a year or two.
What this means for you
- Savings – look at whether your interest beats inflation after tax, and check FSCS protection.
- Gilts – lending to the government. Prices move when interest rates change.
- Investing and pensions – shares have historically had the potential to beat inflation over long periods, but your capital is at risk.
- Mortgages – tracker rates follow Bank Rate, and fixed deals are priced from market expectations.
New to the words? Try the jargon buster.
Sources (checked 12 October 2026): Bank of England Quarterly Bulletin 2014 Q1 – Money creation in the modern economy (McLeay, Radia and Thomas); Bank of England – Bank Rate; UK Debt Management Office – About the DMO; UK Debt Management Office – Gilts in Issue (report D1A); Bank of England – Quantitative easing; Bank of England – Asset Purchase Facility Quarterly Report 2021 Q4; Bank of England – Quantitative tightening: the next chapter, speech by Dave Ramsden (September 2026); Bank of England – APF Gilt Sales Market Notice (17 September 2026); ONS – CPI annual rate 00: all items (series D7G7, dataset MM23); Bank of England – Monetary policy and the 2% inflation target.