Central Banks Are Always Involved With Government Finance

I have been seeing quite a few comments to the effect that central banks are propping up government bond markets now, and what happens if that stops? This is akin to saying the Bears 46 defense was not that good if they did not have all those players who were tackling their unlucky opponents. That is how the system works, and it is a basic misunderstanding to expect things to be different.

I will mainly concentrate on Canada, where Quantitative Easing (QE) is a novelty.  There have been some parallel discussions in the United States, where I will make a few comments (where I do not have strong convictions, so they will be short). 

The easiest way to understand government finance in Canada is to buy my book, which coincidentally has the title Understanding Government Finance (link). In it, I do MMT-style operations analysis on a simplified version of the pre-2020 Canadian system (in Chapter 3). The operations look very different than the pre-2008 U.S. system based on required reserves, which is the basis of most textbook descriptions.

Figure: Bank of Canada balance sheet

The above figure shows the balance sheet structure of the Bank of Canada (BoC) during normal conditions. (Time scale is 2012-2019 to avoid the deviations caused by crises.) The top panel shows that the liabilities of the BoC are mainly two items: bank notes in circulation (dollar bills, coins), and a deposit by the Federal Government (the Receiver General account). All payments to and from the Federal Government end up at this account; the Federal Government does not bank at private banks (at least with respect to Canadian dollars).

The bottom panel is what makes the Canadian system normally different than the U.S.: it shows the deposits at the BoC by the members of Payments Canada (the wholesale payments system), which are private banks. These correspond to "reserves" in American parlance, but is a misnomer since reserve requirement have not existed in Canada since the 1990s. (The Fed finally dropped reserve requirements to 0%, so we might see convergence in terminology.) As the figure shows, banks have a target balance for their overnight balance at the BoC/payments system of $0, and this is for all intents and purposes achieved. (Note that the balances were non-zero during the Financial Crisis, and now as a result of QE).

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