Central bank finances

There is a new BIS paper on the implications of a central bank’s balance sheet.

Abstract:

This paper looks at the relevance of a central bank’s own finances for its policy work. Some central banks are exposed to significant financial risks, partly due to the environment in which they operate, and partly due to the nature of policy actions. While financial exposures and losses do not hamper central banks’ operational capabilities, they may weaken the effectiveness of central bank policy transmission. Against this backdrop, the paper analyses the determinants of a central bank’s financial position and the possible implications of insufficient financial resources for policymaking. It also provides a conceptual framework for considering the question of whether central banks have sufficient financial resources.

Comments

comments

1 thought on “Central bank finances”

  1. Very interesting paper but as Karl Whelan has pointed out the payments system can function fine with an insolvent central bank because the man on the street doesn’t care about the auditor’s concerns.

    There are a number of things in the paper which demonstrate how misunderstood the banking system is though which is worrying.

    1. ”A central bank…can always create money to pay its bills.”

    Most of us would imagine that when the central bank prints money it gains an asset with which to pay its bills. However it gains a liability. (Cash outstanding). This is because a new banknote was once an agreement to pay a quantity of gold and the archaic accountancy procedures of banks haven’t been updated. We should update the system though and record new cash as an asset.

    This is a hugely important point in the context of their analysis and I’ll e-mail the authors but I’m sure it’s something they’ll simply gloss over.

    2. There are a number of references to ”base money can be created as needed” implying that first the central banks create base money and banks multiply the money supply on top of this. However the system works the other way around and as a number of high profile commentators are pointing out an abundance of base money doesn’t lead to more money in circulation when no-one is willing or able to get a bank loan.

    3. Mervyn King doesn’t seem to understand that when a government repays debt to its central bank the money no longer exists.

    ”Bank of England Governor Mervyn King recently dismissed suggestions that government debt held by the Bank could be cancelled…Such an approach would leave the Bank with “no income, in the form of coupon payments on gilts, to cover the [higher] payments of interest on reserves” when interest rates eventually return to a more normal level.”

    When the government repays debt to the central bank the central bank bebits the Exchequer’s account and credits their Debtors account. Two accounting entries decrease and the money no longer exists. How can the central bank possibly pay the money repaid to them to the commercial banks when it no longer exists? It’s unbelievable that the Governor of the Bank of England doesn’t have a good handle on the system.

    It’s just so important that our economists understand the monetary system. I’d encourage all to review my guide to the system at:

    http://sensiblemoney.ie/data/documents/How-Money-Is-Created-And-Destroyed.pdf

Comments are closed.