14.1 The Central Bank’s Balance Sheet #Notebook

14.1 The Central Bank’s Balance Sheet #Notebook

Ultimately the money supply is determined by the interaction of 4 groups, commercial banks, depositors, borrowers, and the central bank. 

The central bank’s balance sheet is composed of assets and liabilities. Its assets include government securities and loans. 

Its assets provide incomes and liquidity. Its assets can use to buy and sell to alter its balance sheet. 

Its liabilities are loans made to commercial banks, but it differs from those of common banks. Its most important liabilities are currency in circulation and reserves.

Currency and reserves are the assets of commercial banks, but not for the central bank.                    

The Federal Reserve notes (FRN), are assets, we owned. But for the central bank, they are liabilities, promissory notes (IOU).

Commercial banks own their deposits in the Fed (reserves), but the Fed owes these reserves to commercial banks.

If Currency in circulation = C , Reserves = R , the monetary base = MB , then the MB = C + R

In the United States, C includes FRN and coins issued by the U.S. Treasury, a relatively small percentage of the MB.

Any FRN in banks is called vault cash and is included in R, which also includes bank deposits with the Fed. 

Reserves include required by the central bank (RR), and additional reserves (ER) that banks hold.

Central banks are highly profitable institutions because their assets earn interest but their liabilities are costless.

Central banks anachronistically own prodigious quantities of gold. Gold is no longer part of the MB. It's a commodity with an unusually high value-to-weight ratio.

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation.  Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.