6.7 Who really signs the banknotes? the central bank's balance sheet and the government

what does the banking system depend on?

base money which is a liability of the central bank

who stands behind the central bank, ensuring we can trust its promises?

the government

**central bank is like other banks in the sense that its liabilities must be matched by an equivalent value of assets

two main categories of liabilities for the central bank

banknotes in circulation

reserves held at central bank by commercial banks

**these are the two forms of base money

has the use of banknotes increased or decreased over time

decreased —> but they’re still in circulation which means that a substantial minority of households don’t have bank accounts

**banknotes are VERY small in comparison to GDP —> banknotes represent a very small fraction of total liabilities in the economy

reserves

deposit accounts held at the central bank owned by commercial banks

commercial banks’ reserve account balances

deposits by commercial banks in their accounts at the central bank

central bank acts as a banker to commercial banks, enabling individual banks to pay each other the net amount each bank owed at the end of the day

**pre financial crisis, reserve balances were typically very small amounts but since then it’s grown significantly

cash ratio deposits

central banks may regulate min level of reserves that commercial banks must hold at the central bank to ensure they have enough liquidity to meet demands for withdrawal of deposits by customers

**very small proportion of total liabilities

what led to the dramatic growth of commercial bank deposits (reserves_

policy of quantitative easing

monetary base

the central bank’s liabilities (banknotes and reserves) together = monetary base

central bank is owned by government

monetary base of the economy is techincally a form of gov debt

gov bonds and quantitative easing

write this out

what are the central bank’s assets?

government bonds that the central bank buys —> these are assets for central bank but liabilites for the government so the government can owe the central bank a lot of money

what happens when government bonds are bought by the central bank?

the debt doesn’t disappear, it just takes a different form

central bank buys existig government debt w/ new base money —> this changes the average maturity of its outstanding debt from mostly long term to short term

short term shows up in increase in bank reserves on which it pays similar interest

examples of times when expansionary monetary policy didn’t work this century

global financial crisis

covid-19

**gov sold bonds and used expansionary fiscal policy to support but in most countries, they also used quantitative easing

does the increase in government debt from central bank buying government bonds cause inflation?

central bank is committed to this anyway

commercial banks make a loan (increasing AD) when they detect a profitable lending opportunity —> the presence of high reserves themselves doesn’t cause them to make loans. the reserves just sit there making interest and the actual existence of them

so basically, no an increase in government debt, even with higher bank reserves, doesn’t automatically cause inflation

inflation only rises if additional debt finance spending significantly increased AD
the central bank failed to offset it by tightening monetary policy

true or false: commercial bank deposits appear as a single line item on the liabilities of a central bank’s balance sheet

false - it shows up as two items: voluntary deposits and required (cash ratio deposits)