In a country like Australia, which uses a fiat currency—money that is created by government decree and not backed by a physical commodity like gold—there are two key ways that money comes into the economy. These are called vertical money creation and horizontal money creation.
Vertical money creation refers to money that is created directly by the currency-issuing government or its central bank. In countries like Australia, the government can create new Australian dollars whenever it spends. When the government pays for things like wages, pensions, public services, or infrastructure, it is putting money into the economy. This is called vertical creation because the money flows from the top—the government—down into the economy. This is the source of new money that allows the rest of the economy to function. Taxation, in this context, is not what funds spending. Instead, taxes help manage demand, give value to the currency, and ensure that people need to use the government’s money to meet their obligations.
Horizontal money creation happens within the private sector, mostly through the banking system. When a bank gives out a loan, it doesn’t hand over money that someone else deposited. Instead, it creates a new deposit in the borrower’s account. This new deposit is treated as new money. The borrower can spend it, and it circulates through the economy. This is called horizontal creation because it happens between players on the same level—between banks, businesses, and households. However, this type of money creation always comes with a matching liability: the borrower now owes the bank a debt of the same amount. In this way, horizontal money creation adds purchasing power but also creates private debt that must be repaid.
The key difference is that vertical money creation adds net financial assets to the economy—it creates money without creating debt for the private sector. Horizontal money creation, by contrast, creates money and debt at the same time, so it doesn’t change the overall net financial position of the private sector.
In short, vertical money creation grows the economy’s financial pie, while horizontal money creation helps shift pieces of that pie around through lending and borrowing. Both are important, but it is vertical money creation that ultimately gives the private sector the dollars it needs to pay taxes, settle debts, and keep the economy moving.