Understanding Money Creation – NationNews Barbados – nationnews.com


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ONE OF MY READERS asked me to explain the concept of printing money in this column. Of course, this does not mean the literal silver print made by British company De La Rue. It is the ability of the central bank to meet government excess spending.

Money creation, which may include printing money, begins with the government’s overdraft facility with the central bank. This corresponds to ten percent of estimated government revenue in a given fiscal year. At the time of the debate on the Estimates, once the appropriation bill has been passed, regardless of the state revenue figure in the document, one tenth of it is the limit of the overdraft. By law, the limit cannot be exceeded.

The Treasury manages the overdraft on behalf of the State. It comes into play if the treasury current account balances are insufficient to meet the daily payable orders received from the State. In short, when the government has insufficient income, it borrows temporarily through the central bank‘s overdraft facility.

For several years, the State has not been able to reduce the balance of the overdraft facility when it comes to temporary loans. In practice, the balance should be zero at the end of the year.

Since this overdraft has not been cleared for several years, the Central Bank lends money to the government in an alternative way to finance its excess spending. This loan is made through the purchase of government treasury bills and debentures.

When an allocation of Treasury bills is not taken up by market players, the Accountant General can ask the Central Bank to make up the shortfall. Like any other purchaser, the bank is requested to pay to the Treasury on the date of issue the cost of the bonds less the interest due.

Securities

In recent times, the securities are not issued and the Central Bank has asked to fill the shortfall, the bank plays a major role in purchasing the securities from the start. This is because everything that comes as a policy these days is really designed to accommodate the government. Tax policies must take into account the government’s fiscal madness.

In recent times, the central bank’s monetary policy has also been designed to accommodate the government. This is true with regard to the purchase of government securities. This is the case with the deregulation of minimum deposit rates. This is true with regard to the fixing of Treasury bill rates.

When the bank holds government paper, it essentially gives a loan. The loan is used to pay for payable orders cashed daily. Accounting in the Treasury is a matter of debiting and crediting the good general books.

The real problem is where does the central bank get the money to buy the securities from? This is where the concept of money creation comes in. Not all the money that is created is printed.

In recent times, the Central Bank has collected excess commercial bank deposits held at the bank and used them to purchase government securities. It is not common. If commercial banks turned to the central bank for their excess deposits, a thing or two should happen.

First, the bank would have to break its titles with the government, which would reduce the loans it would receive. This would mean a lack of funding for the government.

Second, the bank would then have to print money to consolidate its funding with the government.

Under these circumstances, a major problem could arise in the future with the Central Bank. Since part of the money used to buy its holdings of government securities belongs to the commercial banks, they could demand their money at any time. The Central Bank would then have to print money.

When the central bank buys government securities, these become part of the government’s domestic debt. In the second quarter, from April to June 2016, commercial banks reduced their loans to the government by $ 120 million. They did, however, place $ 198 million in excess deposits with the central bank, which the bank used to buy government securities. The bank then printed $ 103 million in cash to purchase additional government securities.

The next article is, why does using money from commercial banks to buy government securities not affect foreign exchange reserves?

• Dr Clyde Mascoll is an economist and the Barbados opposition Labor Party economics advisor.

About Ruben V. Albin

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