The Library of the Canadian Parliament issued a document in 2015 explaining how the Bank of Canada (that country's central bank) created money for the Canadian federal government. Since most people doubt this even happens, it seems well worthwhile sharing this document to record, firstly, to note that there is nothing odd about this, and second, that there is no mystery to the processes involved, except as they note in the preface to the document:
The process by which money is created is so simple that the mind is repelled.
— John Kenneth Galbraith
Their conclusion is critical:
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.
As a matter of fact, all central banks, including the Bank of England, create money on behalf of their governments. It is just what they do, and no one but the government and the central bank is involved in the process.
Introduction
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 money1 for the federal government. Information about how private commercial banks create money is also provided.
In June 2011, as part of the debt management strategy2 included 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 of this "prudential liquidity plan," as it is known, is to ensure that there are 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.
The government justified this plan by stating that liquid financial assets "safeguard its ability to meet payment obligations in situations where normal access to funding markets may be disrupted or delayed," and that this "supports investor confidence in Canadian government debt."3 In response to the government's June announcement, in October 2011, the Bank of Canada announced its intention to increase from 15% to 20% its minimum purchases of federal government bonds.4 As explained in this paper, 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 Government of Canada may elect, as it did in the context of the prudential liquidity plan, to keep this money in its deposit account with the Bank rather than spend it.
How the Bank of Canada Creates Money for the Federal Government
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. However, the Bank of Canada itself typically 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.5 These 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.6
In practical terms, 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, and it simultaneously records the proceeds of sale of the securities as a deposit in the Government of Canada's account at the Bank — a liability on the Bank's balance sheet (see Appendix A). 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.
Since the Bank of Canada is a Crown corporation wholly owned by the federal government, the Bank's purchase of newly issued securities from the federal government can be considered an internal transaction. 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.
Despite the fact that 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's governing law, the Bank of Canada Act,7 does not explicitly empower the Bank to make loans of this nature.8 Rather, the Act gives the Bank the power to "buy and sell securities issued or guaranteed by Canada or any province" (section 18(c)) as well as the power to "accept deposits from the Government of Canada and pay interest on those deposits" (section 18(l)). Those two provisions, taken together, appear to empower the Bank to create money through the direct purchase of Government of Canada securities at debt auctions.
Money Creation in the Private Banking System
Private commercial banks also create money — when they purchase newly issued government securities as primary dealers at auctions — 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 bank.
However, it is important to note that money is also created within the private banking system every time the banks extend a new loan, such as a home mortgage or a business loan. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money (see Appendix B). 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 realised 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.9 In contrast, 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. The limiting rules, known as "capital constraints," are set by the banking regulator in guidelines.10 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.
Conclusion
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, 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 market dysfunction, cannot cause the federal government to run out of money.
Papers in the Library of Parliament's In Brief series are short briefings on current issues. At times, they may serve as overviews, referring readers to more substantive sources published on the same topic. They are prepared by the Parliamentary Information and Research Service, which carries out research for and provides information and analysis to parliamentarians and Senate and House of Commons committees and parliamentary associations in an objective, impartial manner.
- For the purpose of this publication, "money" means bank deposits.
- Government of Canada, "Annex 2: Debt Management Strategy for 2011—12 (June 6, 2011)," in The Next Phase of Canada's Economic Action Plan: A Low-tax Plan for Jobs and Growth, 6 June 2011.
- Department of Finance Canada, "Government of Canada Will Complete Funding of Prudential Liquidity Plan Ahead of Schedule," News release, 14 February 2013.
- Bank of Canada, "Changes in Minimum Bank of Canada Nominal Bond Purchases at Auctions," Notice, 19 October 2011.
- Bank of Canada (19 October 2011); and Bank of Canada, Statement of Policy Governing the Acquisition and Management of Financial Assets for the Bank of Canada's Balance Sheet,
(158 kB, 10 pages) 24 August 2011, p. 4. - Bank of Canada (24 August 2011), p. 3.
- Bank of Canada Act, R.S.C. 1985, c. B-2.
- The Bank of Canada Act empowers the Bank of Canada to:
- "make loans or advances for periods not exceeding six months to the Government of Canada … on taking security in readily marketable securities issued or guaranteed by Canada" (s. 18(i)); and
- "make loans to the Government of Canada …, but such loans outstanding at any one time shall not, in the case of the Government of Canada, exceed one-third of the estimated revenue of the Government of Canada for its fiscal year, … and such loans shall be repaid before the end of the first quarter after the end of the fiscal year of the government that has contracted the loan" (s. 18(j)).
However, it appears that neither of these two provisions, which require loan repayment within a specific and relatively short time frames, provides authority for the type of loans the Bank makes to the federal government by buying a portion of all new federal government securities, which the Bank holds until maturity. [ Retour au texte ]
- There may be internal government constraints on the Bank of Canada in the form of laws, passed by Parliament, that regulate borrowings by the Government of Canada. There are also practical constraints. For example, large amounts of new money, if spent in the Canadian economy, would lead to inflation. However, money created and not spent, such as the $35 billion created for the prudential liquidity plan, does not cause inflation. [ Retour au texte ]
- In Canada, the banking regulator is the Office of the Superintendent of Financial Institutions [OSFI]. See OSFI, Table of Guidelines for more details. Although capital constraints are set out in guidelines rather than in law or regulation, the guidelines are effectively mandatory for banks. [ Retour au texte ]
Appendix A — Money Creation as an Internal Process Within the Federal Government
This chart illustrates the impact on the balance sheets of the Bank of Canada and the Government of Canada when the Government of Canada issues new securities and these are purchased directly by the Bank of Canada.
Appendix B — Money Creation in the Private Banking System
This chart illustrates the impact on the balance sheets of a private commercial bank and a private entity when the bank provides a new loan to the private entity.
Taking further action
If you want to write a letter to your MP on the issues raised in this blog post, there is a ChatGPT prompt to assist you in doing so, with full instructions, here.
One word of warning, though: please ensure you have the correct MP. ChatGPT can get it wrong.
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I am certainly convinced that this is an unarguable fact and that much falls out of that that populates the assertions of MMT. We are, though, living in a global wonderland of neoliberal adherence and I caught this video on Youtube that expresses this difference quite well https://youtu.be/OOlnNvNzCUw?si=nrk0syCuioribc3b
This is an issue that I have (no doubt owing to my lack of knowledge and experience) for some time struggled to resolve for myself: wouldn’t the fantasy economics of neoliberalism as expressed in the markets have real world effects on attempts to implement MMT based policies of investment? With reference todays video on the ‘Con’ this is an argument I have no ammunition for.
You can’t implement MMT. It already happens. What you can do is understand what happens so you can be empowered to do what is possible.
That doesn’t really answer my question. A policy of investment in services informed by an understanding of MMT is what you (and I and many others who subscribe to your channel) would like to advocate for. The argument put forward in the video I linked is that markets are driven by neoliberal thinking and would react to significant levels of investment – however justified by the reality of MMT – by signalling a loss of confidence in the British economy and selling bonds en masse, and, I assume, devaluing the currency and potentially increasing international borrowing rates for the UK.
If this is not likely to be the case or that it would’t adversely affect the UK if it did are the sort of counter arguments I’m looking for – and of course the reasoning behind them. This is not a challenge, just a bid for clarity.
These games cannot be sustained by market traders
Long term savers look at fundamentals – and they know investment means growth and improved returns.
Don’t fall for false narratives. Markets really won’t act against their own best interests and investment = growth = improved market returns = more saving in stock markets and = increased value of the pound.
Re a troublesome bond market, Prof Werner (first in context of Eurozone/Troika/Greece) suggested ‘Enhanced Debt Management’ – ‘The government can increase bank credit creation for GDP transactions, and hence nominal GDP growth (and hence job creation and prosperity), by the relatively simple measure of stopping the issuance of government bonds and instead borrowing the funds required for the public sector borrowing requirement directly from the banks in the UK.’ (Borrowing at lower and fixed rate) https://committees.parliament.uk/writtenevidence/78602/html/
Well………………….’Follow that’, as they say!
Margaret Thatcher eh, what a lying toad she was………………………..and the source of a deformed political economy.
🙂
I want to offer an answer to a question posed in many of the comments on various blogs over the past few days.The question is a simple one: Why do governments, almost all politicians, and most political commentators, peddle the claim that government finance and spending is the same as that of a household?
The short answer is: ignorance, ideology and cowardise. They are not mutually exclusive and they all relate to a fundamental truth about what politics is: Harold Lasswell’s ‘Politics: Who Gets What, When and How’ (1936). This approach requires that those involved in politics must examine potential policy options, and then make choices and take tough decisions, and thus decide, whose going to get what, when and how.
However – and this is of fundamental importance – politicians, and especially those in government, are then going to be asked, and have to justify, WHY they made the decisions they did. This can be, and more often than not is, an uncomfortable experience – witness members of the government and Civil Service appearing before Select Committees. Not only is it an uncomfortable experience, it’s also time consuming (you have to get your head around your brief, as it were, and facts and figures), but, even more concerning, it can be career defining or destroying – which, if you’re a politician wanting to get on in the world, is not a risk worth taking.
And so, since the 1970s, an increasing number of the people involved in politics (now almost everyone) began to realise that the most effective way to avoid being held to account over ‘who gets what, when, how and why’, was to shift the focus of politics away from politicians having to make choices, decisions, and so on, and instead blame everything on ‘There is no money left.’ That is, create and then cement the illusion that a government functions exactly as a household. After all, everyone can understand that as it’s common sense, isn’t it?
Furthermore, shifting the blame away from themselves, also appeals because its simple (and thus appeals to the ignorant); ideologically appealing (to small government types, etc); and finally, it appeals most especially to cowardice – a quality most contemporary politicians posses in spades.
There you have it: Ignorance, ideology and cowardise. And they’re all central to sustaining neoliberalism too, of course.
Thanks Ivan.
Much appreciated.
You might see a poster sometime based on this.
Just to mention that I experienced a glitch in your word counter with this comment. When I got to the end the on screen counter told me I had six words left. But when I tried to submit it told me I was over by eight words (hence mention of laziness had to be cut out).
Did you make revisions?
It seems I can count them. We are looking at it.
Mr Horrocks, I’m not convinced. Paras 3 & 4 (Know your brief (or not) & avoid at all costs any blame) can be countered by the facts outlined in the Canadian paper: in fiat currency land, govs cannot run out of money. “Ignorance, ideology and cowardise” handmaidens of neoliberalism – yup buy that.
Brown is a good example of ignorance and ideology. But, if I may suggest, you have missed something out: a lack of curiosity. My Austrian economist friend finds a lack of curiosity amonst those in positions of power – frightening.
It could be that lack of curiosity is linked to cowardise – an unwillingness to even consider alternatives (Thatcher & TINA) – in case this starts to destroy belief systems & thus the foundations which people build in order to allow them to function. Brown KNEW he could order the BoE to print – why didn’t he? (corrupt, stupid/ignorant, an ideologue,…..). I think we need to dig deeper.
Thanks Mike
Mr Parr (Mike). A fair critique. To be honest, I ran out of words. I wanted to mention laziness – which could easily mesh with your lack of curiosity, or indeed, a desire not to “rock the boat/challenge conventions”. So I stuck to what are in my experience the three most important and easily observable in a our politicians.
You can have an exception – would you like one?
I agree very much with Mike P and others: cowardice, ignorance, laziness, lack of curiosity, and, I would add, self-interest. The days when the Labour Party conference had some meaning and was a home to widespread debate are long passed. Today it’s more of a Stalinist organisation run by a tiny executive which hands down the party line and disciplines anyone who deviates from it. Hence the idea of an MP saying publicly that the government’s economic policy is based on, as is easily proved to be, a lie, isn’t going to happen. Even any distinguished ex-cabinet member would need to have considerable courage to say they’ve realized they were wrong in the past and things absolutely have to change because it’s all based on a lie. I mean, what would happen? The TV news anchor/correspondent would splutter in confusion, treat them as laughable, and they’d be ostracized by their former colleagues.
This leads me to two conclusions:
1. That we need a new political party rooted in real world politics.
2. But as of now we should make influencing Union executives and members, and most especially the Public Sector ones, a key priority.
The fact that money is created in the way described is irrefutable.
The question then becomes why the explanation of money creation offered via the media is turned on its head so that labour precedes, and is a necessary condition of, the availability of funding.
This is obviously the case if you are a binman, if you don’t turn up to empty the bins you are not paid.
But it is obviously false for investment purposes, limited liability was created to cover the associated investment risk. The creation of the credit preceded the venture.
I can only surmise that there is a belief that if the masses thought that money creation did not follow labour then the bins would not be emptied.
On a tangent – Bankman- Fried created 350 million FTT tokens in 2019 which he initially offered to buyers at 5 cents, months later they were trading at one dollar 50 cents.
I admit I do not really follow your example, and am not at all sure what limited liability has to do with it. That prevents ex post losses, but does not ex ante have any relationship with money creation that I can think of.
Does the government have to pay interest to the central bank on the securities it issues as per your ‘ internal process of government’ diagram? Thanks
It pays it, and then gets it back. It owns the central bank.
I am an ordinary person & a follower of Gary Stevenson. He has a talent for explaining economics to a layman like me.
Having read your piece about governments creating money, I find it extremely difficult to understand. I also notice that many of the comments appear to be made by very educated people, so their arguments go straight over my head too. As you say that you & Gary have much common ground, I implore you to speak with him & ask him to find a way of explaining it in a way that ordinary folk can understand. I suspect that he uses the analogy of household economics because he knows how difficult the realities are to explain.
You need us on your side too!
But we have to get things right
You cannot win argyments on the basis of wrong assertions
Sorry, but that’s a fact
[…] all central banks that have commented on the issue. The Bank of England confirmed this in 2014. The Bank of Canada did in 2015. Money creation is that simple. In fact, it is so obscenely simple that people recoil from the idea […]