THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 437

CHAPTER 16 The Money Supply Process 405 Of the three players, the central bank, the Bank of Canada, is the most important Its conduct of monetary policy involves actions that affect its balance sheet (holdings of assets and liabilities), to which we turn now THE BAN K O F CA NA DA S BAL AN CE SHE ET The operation of the Bank of Canada and its monetary policy involve actions that affect its balance sheet, its holdings of assets and liabilities Here we discuss a simplified balance sheet that includes just four items that are essential to our understanding of the money supply process.1 Bank of Canada Assets Government securities Advances to banks Liabilities Liabilities Notes in circulation Reserves The two liabilities on the balance sheet, notes in circulation and reserves, are often referred to as the monetary liabilities of the Bank of Canada They are an important part of the money supply story, because increases in either or both will lead to an increase in the money supply (everything else being constant) The sum of the Bank s monetary liabilities (notes in circulation and reserves) and the Canadian Mint s monetary liabilities (coins in circulation) is called the monetary base When discussing the monetary base, we will focus only on the monetary liabilities of the Bank of Canada because the monetary liabilities of the Canadian Mint account for a very small fraction of the base.2 Notes in circulation The Bank of Canada issues notes (those blue, purple, green, red, and brown pieces of paper in your wallet that say Bank of Canada ) The Bank of Canada notes in circulation is the amount of these notes that is in the hands of the public and the depository institutions Coins issued by the Canadian Mint are not a liability of the Bank of Canada The coins and Bank of Canada notes that we use in Canada today are collectively known as currency Bank of Canada notes are IOUs from the Bank to the bearer and are also liabilities, but unlike most liabilities, they promise to pay back the bearer solely with Bank of Canada notes; that is, they pay off IOUs with other IOUs Accordingly, if you bring a $100 bill to the Bank of Canada and demand payment, you will receive two $50s, five $20s, ten $10s, or twenty $5 bills People are more willing to accept IOUs from the Bank of Canada than from you or me because Bank of Canada notes are a recognized medium of exchange; that is, they are accepted as a means of payment and so function as money A detailed discussion of the Bank s balance sheet and the factors that affect the monetary base can be found in the appendix to this chapter on this book s MyEconLab at www.pearsoned.ca/myeconlab It is also safe to ignore the Canadian Mint s monetary liabilities when discussing the monetary base because the Canadian Mint cannot actively supply its monetary liabilities to the economy because of legal restrictions