Endogenous money theory explains that most money in modern economies is created by commercial banks through the lending process, not by central banks printing cash. When a bank approves your mortgage or business loan, they don't transfer existing deposits from other accounts. Instead, they create new money by crediting your account with the loan amount while simultaneously creating a corresponding debt obligation. This process happens millions of times daily as banks respond to loan demand from creditworthy borrowers. The money supply therefore expands and contracts based on private sector demand for credit, making it 'endogenous' - determined from within the economic system rather than externally imposed by monetary authorities.
Understanding endogenous money reveals why traditional economic models that assume fixed money supplies are flawed. It explains how financial crises can cause rapid money supply contractions as lending stops, and why central banks must accommodate the banking system's liquidity needs rather than directly controlling money creation.
Example / analogy
Think of money like library books that are created when readers request them, rather than a fixed collection. When you 'borrow' money, the bank creates both the book (your deposit) and the library card showing you owe it back. The total number of books grows with reader demand.