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For Your Information How the Bank of Canada Creates Money for the Federal Government: Operational and Legal AspectsNote that for the purpose of this publication, "money" means bank deposits. For the complete document click here. This paper explores the operational and legal aspects of how, by buying newly issued federal government bonds and treasury bills, the Bank of Canada creates money for the federal government. Information about how private commercial banks create money is also provided. In its 2011 Budget, the Government of Canada announced its intention to borrow $35 billion over the next three years in order to increase its deposits with financial institutions and the Bank of Canada by about $25 billion and to increase liquid foreign exchange reserves by US$10 billion. The intention was to ensure sufficient liquid assets to cover at least one month of the federal government's net projected cash flows, including interest payments and debt refinancing needs. In response, the Bank of Canada announced its intention to increase from 15% to 20% its minimum purchases of federal government bonds. The Bank of Canada's purchase of federal government bonds is a means by which the Bank creates money for the Government of Canada. The Bank of Canada helps the Government of Canada to borrow money by holding auctions throughout the year at which new federal securities (bonds and treasury bills) are sold to government securities distributors, such as banks, brokers and investment dealers. (Typically, private interests purchase 80% of the newly issued bonds and treasury bills) while the Bank of Canada itself purchases 20% of newly issued bonds and a sufficient amount of treasury bills to meet the Bank's needs at the time of each auction. These (Bank) purchases are made on a non-competitive basis, meaning that the Bank of Canada does not compete with the distributors at auctions. Rather, it is allotted a specific amount of securities to buy at each auction. The Bank of Canada's purchase of government securities at auction means that the Bank records the value of the securities as a new asset on its balance sheet. The Bank simultaneously records the proceeds of (the government's) sale of the securities as a deposit in the Government of Canada's account at the Bank, (which becomes) a liability on the Bank's balance sheet. No paper evidence of a bond, treasury bill or cash is
exchanged between the Government of Canada and the Bank of Canada
in these transactions. Rather, the transactions consist entirely
of digital accounting entries. By recording new and equal amounts on the asset and liability sides of its balance sheet, the Bank of Canada creates money through a few keystrokes. The federal government can spend the newly created bank deposits in the Canadian economy if it wishes. The Bank of Canada's creation of money for the federal government is achieved through de facto loans from the Bank to the government. The Bank of Canada Act gives the Bank the power to "buy and sell securities issued or guaranteed by Canada or any province" as well as the power to "accept deposits from the Government of Canada and pay interest on those deposits." Those two provisions empower the Bank to create money through the direct purchase of Government of Canada securities at debt auctions. Private Commercial Banks Also Create MoneyPrivate commercial banks also create money when they purchase newly issued government securities as primary dealers at auctions. (They do so) by making digital accounting entries on their own balance sheets. The asset side is augmented to reflect the purchase of new securities, and the liability side is augmented to reflect a new deposit in the federal government's account with the (private) bank. (Also) every time (private) banks extend a new loan, such as a home mortgage or a business loan (they create money). Whenever a bank makes a loan (to a business or individual), it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money. Most of the money in the economy is, in fact, created within the private banking system. A key similarity between money creation in the private banking system and money creation by the Bank of Canada is that both are realized through loans to the Government of Canada and, in the case of private banks, loans to the general public. One difference between the two types of money creation is that there is no external limit to the total amount of money that the Bank of Canada may create for the federal government. The amount of money that a private commercial bank is permitted to create depends on the amount of the bank's equity relative to its assets, which is set by the banking regulator in guidelines. Another difference is that the creditworthiness of the borrower is the key factor in the decision by a private commercial bank to provide a loan to a private entity, while this is not a factor in the Bank of Canada's decision to lend money to the government. Both private commercial banks and the Bank of Canada create money by extending loans to the Government of Canada and, in the case of private commercial banks, (also by) lending to the general public. The Bank of Canada's money creation for the Government of Canada is an internal government process. This means that external factors, such as financial markets dysfunction, cannot cause the federal government to run out of money. Note: In managing its balance sheet, the Bank of Canada acquires Government of Canada securities to offset its liabilities, which consist mainly of bank notes in circulation and deposits. The Bank typically acquires a fixed percentage of the amount of nominal bonds being auctioned, with the amount of treasury bills purchased reflecting the Bank of Canada s balance sheet needs at the time of each auction. Generally, the Bank of Canada s holdings of financial assets are driven by its role in issuing bank notes. The issuance of bank notes creates a liability for the Bank, the largest on its balance sheet. Government of Canada deposits typically represent the second largest liability for the Bank. (Source: Library of Parliament, 2015 (excerpts))
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