I was hoping to spend a much time on the glossary this week as I did last, but a tsunami of other work has meant that has not happened. Large numbers of words are being written on everything from academic journal papers, other articles, House of Commons evidence submissions, and more, but not as much as I want on the glossary. However, these two git put our yesterday partly because they support that submission of evidence. Any thoughts? And please note, earlier comments on other issues are now being edited into those entries.
‘Base money' is sometimes called ‘central bank money'. It comprises the currency issued by central banks in the form of notes and coins and what are called the central bank reserve account balances or central bank reserve accounts. These balances are the sums owed by the central bank to the commercial banks that hold accounts with that central bank as a requirement of banking regulation.
The central bank reserve accounts serve two purposes. Firstly, they provide the mechanism by which payments from commercial banks and their customers are made to and from the government. Secondly, they are the mechanism used by commercial banks to make settlement of the liabilities that they owe each other when fulfilling the obligations that their customers' request be settled with customers of another bank.
The central bank requires that the commercial banks hold funds in their central bank reserve accounts. As a result, these accounts are always liabilities of the central bank and assets of the commercial banks. Whilst the sum each bank might hold in its central bank reserve account will vary as inter-bank settlement takes place the quantum of funds in the overall central bank reserve accounts is always under government control and is determined by its decisions on the amount it spends (which creates new central bank reserve account balances), the amount it taxes (which removes money from these accounts), and the amount it issues in bonds (which also reduces the central bank reserve account balances since those buying bonds then have a different liability owing to them by the government). As such the overall central bank reserve account balances and so the quantity of base money is under central bank control.
See also base money.
This entry explains how central bank reserve accounts are created.
Central bank reserve accounts (CBRAs) are held by the UK's commercial banks with the UK's central bank – the Bank of England.
As a central bank, the Bank of England is owned by the UK government. It is responsible for the day-to-day management of the money supply in the UK; for the regulation of commercial banks in the UK and for managing the settlement of inter-bank debts in sterling, for the issue of which currency it is responsible.
The central bank reserve accounts serve two purposes. Firstly, they provide the mechanism by which payments from commercial banks and their customers are made to and from the government. Secondly, they are the mechanism used by commercial banks to make settlement of the liabilities that they owe each other when fulfilling the obligations that their customers' request be settled with customers of another bank.
These accounts are as a result restricted for the use of commercial banks and some other regulated entities in the financial services industry. It is believed that there are only a few hundred of them as a result.
Second, note that before 2007 there were almost no such balances, at least in total. The commercial banks and the Bank of England sought to achieve this result each day but used other very short-term overdraft and loan arrangements if that was not possible at that time. The current situation where all CBRAs are, in effect, bank deposit accounts held by the UK's commercial banks as a mechanism to guarantee their ability to make settlement to each other is almost entirely a creation of the post-2008 global financial crisis as a result.
Third, note that this change was in no small part motivated by those banks refusal to trust each other to make settlement after 2007, in which year it became clear that major commercial banks could fail when none had effectively done so since the 1860s. Once banks had demonstrated their own inability to manage their balance sheets at the time of the global financial crisis it became apparent that these banks would need to hold funds with the Bank of England to prove their ability to fulfil their own promises to pay.
Fourth, the central bank reserve accounts were deliberately boosted in value by the Bank of England to facilitate this inter-bank payment process. This was the way in which banks were bailed out post-2008 to prevent them failing again.
In that case the way in which these reserve accounts have been increased in value needs to be noted. Doing so requires four things to be understood:
- Overall, the sum held on these accounts is not within the control of the commercial banks. The sum that each bank might hold will vary from day to day. However, that is the consequence of payments between banks varying. However, the quantum of funds held in the CBRAs as a whole is determined by the Bank of England on behalf of the government because it is the sole creator of what is called ‘base money'.
- ‘Base money' is sometimes called ‘central bank money'. It comprises the currency issued by central banks in the form of notes and coins plus the balances on the CBRAs.
- Base moneyis created as a result of the CBRAs being used to transfer funds from the Bank of England into commercial banks on behalf of the government, to whom it acts as primary banker through the Consolidated Fund, and to also receive payments from those banks that are due to the government.
- In summary, payments from the Bank of England Consolidated Fund account to the commercial banks increases the sums held in the central bank reserve accounts and so create what is called base money. These payments are made in the ordinary course of government business to make settlement to whomsoever the government chooses to make payment to, from an old age pensioner to the sums used to redeem gilts when they reached their repayment date. Payments to the government via the CBRAs include taxes due, the proceeds of new gilt issues and the receipt of the many trading sums owed to government agencies.
In that case the only way in which the balances on the central bank reserve accounts can increase is by the government spending more into the economy than it receives back from it. There is no other way in which this can happen. In turn that is only possible because the government can decide to fund its expenditure with new money created on its behalf by the Bank of England. That new money that the Bank of England creates for the government is base money.
The corollary is also true. The only way in which the balances on the CBRAs can be reduced is by the government collecting more money from the commercial banking system than it spends into the economy e.g., as a consequence of taxes paid being in excess of government expenditure, or by raising new borrowing in excess of current requirements e.g. because of quantitative tightening.
In this context, the role of quantitative easing can appear to be confusing, although it is actually quite straightforward. The pattern is as follows:
- At any time it wishes the government can decide to issue now financial instruments. These can be very short term, in which case they are described as Treasury Bills and are redeemed in days. Alternatively, they can issue bonds or gilts, which can have duration from a year or so to fifty years or more. It has been government practice to only issue such bonds when there is a deficit on its Consolidated Fund account with the Bank of England, the aim being to restore a neutral balance on that account. This, however, is not a necessity and before 2008 it was commonplace for this account to also be cleared through the so-called Ways and Means Account that the government maintained with the Bank of England, which was an overdraft in all but name.
- The issue of new financial instruments, of whatever their nature, results in new financial flows from the commercial banks to the government either because the banks themselves buy these instruments or, more commonly, because their customers do. These flows move through the CBRAs in either case since this financial conduit to and from the government is only available to the banking sector and a very select limited number of other financial services sector entities. Whether the payment the commercial bank makes is as principal or agent for their customer makes no difference: the flow is from them to the government via the central bank reserve accounts. The result of the issue of new bonds is to reduce the balance in the CBRAs, meaning that the balances on those accounts created by government spending being in excess of routine income are cancelled in whole or part. Bond issuance of this sort, it is stressed, is not a part of the quantitative easing process.
- If the Bank of England then decides to undertake quantitative easing all that it does is lend funds to its legal subsidiary, the Bank of England Asset Purchase FacilityFund Limited (the ‘APF'). This company is fully indemnified with regard to its activities by HM Treasury and as such an agent of Treasury and is not under the effective control of the Bank. That company then uses the loan funds provided to it by the Bank of England to buy bonds issued by HM Treasury on the open financial markets. There is no reason why these bonds need to be owned by the commercial banks, and it is likely that most of them will not be. This is inconsequential to the resulting movement through the central bank reserve accounts, which is represented by a flow of funds from the account of the APF to the commercial banks, which as a result increases the central bank reserve accounts balances.
- As a result bond issues cancel the CBRAs created by government spending being in excess of government income, and QE then in turn cancels that process, as if the bond issue never took place., effectively restoring the CBRA balances created by expenditure exceeding income. Given that the bond that was issued is, after being repurchased using QE under the effective ownership and control of HM Treasury it is easy to argue that the bond in question has effectvely been cancelled. This is the accounting position reflected in the Whole of Government Accounts, which are the only true and fair accounting representation of this transaction[1].
- QE is then a simple way of swapping bonds that need never have been issued for base money, and QT reverses that swap.
As a result the reality is that QE and QT are window dressing and it is the excess of government spending over income and routine bond issuance since 2008 that has created the CBRA balances.
[1] https://www.gov.uk/government/collections/whole-of-government-accounts
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Typo: under CBRAs:
“Second, note that before 2007 there were almost no such balances […] The current situation where all CBRAs are, in effect, bank **despot** accounts”
Although I do appreciate the aptness of **despot** 😉
To be corrected
Thanks
“The current situation where all CBRAs are, in effect, bank despot accounts held by “. I like the idea of despot accounts.
Oops…
To edit
The best way to provide what you have written, I think would be to show the ‘T’ account workings, pro forma (to establish the principles, not literally to mirror the exact tranactions); but I am not sure how easy that is to do in the digital format of the Blog; but I think the ‘T’ account is by far the better, and clearest way to present the information. As I read your draft I started to try and think of the T-account implications, but it is quite hard to follow through; which, for me, made the point.
I also think that T-accounts reveal the critical nature of money, existentially as essentially a double-entry accounting phenomenon (which I have always thought why economists don’t ‘get it’). It lives in a quasi-quantum world, appearing before us; only to disappear before our very eyes.
I could post the explanation of the double entry but as very few accountants now seem ti udnertsand T accounts I am not sure how that would really help now
It is a lost language as IT does the double entry for people now
I still do extended trial balances as I learned some of mu trade in a small firm, but thinmgs have come a long way since then
“very few accountants now seem ti udnertsand T accounts I am not sure how that would really help now”.
You certainly know how to scare me to death, because I believe that T-accounts reveal the critical nature of money, existentially as essentially a double-entry accounting phenomenon. Mehrling teaches monetary economics through T-accounts!
But now one now writes them up
So the skill is going
I do hope there will be an entry on double-entry bookkeeping in the Glossary.
So much of the academic work on the UK Exchequer operations uses the language of liability, credit, assets… and the published Whole of Government Accounts really need double-entry to follow the trail. We don’t all have IT.
Certainly the AGMs of playgroups, PTAs, Union branches, local councils need the understanding of basic double-entry principles if their accounts are to be fully scrutinised and they are to be held accountable. I’ve not encountered many gatherings where accounts are ever questioned, because of a lack of knowledge.
Double-entry bookkeeping ought to be on the curriculum. A glossary entry could be a useful substitute!
I am planning a whole section on double entry and the terms related to it
That section is reasonable far advanced
When I can get rid of the work I will be back on such things, I promise
Bit the other work is important too
Is it worth mentioning that “Reserve Accounts” were called “Exchange Settlement Accounts” before 2005. They still are in Australia. I tend to use the latter term with the former in brackets in my own writing. To me the latter is an Americanism which was meant to distance the Federal Reserve, when created in 1913, from commercial banks at a time of deep distrust of them.
It looks like this glossary is becoming as big as the OED.
I fear that it might do
And also an unworried by that fact
Thank you very much, and keep them coming. For someone who is admittedly in the phase of learning about economics, each entry gives me some new insights.
Thanks
13,000 words in the last two days on other issues have distracted me
But by Tuesday I should be back on this
When the government pays a third party through a commercial bank’s CBRA then that bank is providing a service to the government and it seems reasonable that it should be paid for doing so. Rather than paying for the service by paying interest on the CBRA balance it seems more logical to pay for it by paying the bank a small percentage when the payment to the third party is made. This percentage could cover the cost to the bank of providing the service plus a reasonable profit. Unless the third party withdraws the money as physical cash, it will effectively remain in the banking system for ever and the commercial banks are effectively being paid for ever for services they are providing today.
If you could go to the bank and force them to loan you whatever you want at whatever interest rate you dictate for however long you want to hold that money without demanding any further collateral is that the bank creating money, or you?
Banks lend money to the central bank in the same way you lend money to a bank when you hold a deposit. That’s why it is called a ‘credit’ balance – credit being the accounting term for a liability.
That’s just a function of bank accounting being backwards from normal accounting. For a firm a deposit is an asset and a loan a liability, for a bank a loan is an asset and a deposit a liability.
The central bank can force other banks to create money. That’s what matters – not that the accounting looks wrong.
I am not sure what your point is
The Asset Purchase Facility is an interesting name for the financial instrument the BoE/Treasury has set up to buy Government issued bonds which are also called “Government debt”.
So in effect when the BoE looks at this it says we have an asset , while the govt looks at the same situation and calls it a debt. So this could be called the Debt Purchase Facility too.
Welcome to the world of money creation, or as I view it, “Schrodinger money” in that is both is a debt and asset at the same time and only materialises as a debt or asset depending on how you look at it.
This is an archaic way of doing things,set up in days gone by when banks really did lend “money” to the Sovereign (or at least gave the Sovereign credit). We don’t have that situation now since the nationalisation of the BoE, but we still like to jump through the old hoops of how things were done…..really needs updating now though.
Money is an entity that only exists in a quantum reality. It can only be in two places at the same time: debit and a credit. Every debt is someone’s asset. In the case of real money (the money at the top of the hierarchy – the stuff that is still money after the big crash), the debtor is always the sovereign power; the Government. Every other form of credit collapses, or runs and hides
Very neatly put