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Lesson 2, Topic 8
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8. What does the government’s money creation look like in the simplest case? For example, in Canada?

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In Canada, the Ministry of Finance and the Central Bank can organize the state’s money creation directly among themselves. Let’s look at how this works in a somewhat simplified form, as a vivid two-person play. Imagine the Canadian Finance Minister needs 50 billion Canadian dollars for government policy. In this case she can directly communicate with the Bank of Canada. She issues government bonds worth 50 billion dollars and hands them over to the central bank. She then receives a credit of 50 billion brand new Canadian dollars in central bank money into the government account in return. In the form of simplified T-accounts, this money creation process would look like this:


These T-accounts look very similar to the ones in the example of Marta’s bank loan for a racing-bike. Again, new money is created as the creator and the recipient exchange assets and liabilities in a mirror-image manner. In this example, the central bank creates 50 billion Canadian dollars by registering them on the assets side of the government’s central bank account. To balance this, on the government’s liabilities side a debt is registered, which is represented by the bonds. The government commits to return 50 billion Canadian dollars at the end of the government bond´s term. 

In the central bank’s T-account, the same items are entered the exact other way round: the government’s debt in form of the bonds are registered on the assets side, as for the central bank they represent a claim to demand money from the government at the end of the term. But the central bank now also has a debt. It has assured to provide the government with 50 billion Canadian dollars and pay it out in cash if necessary or, more likely, transfer it on behalf of the government. Again, the money created is a debt to the money creator. And again, both parties have exchanged liabilities and in doing so are turning the debt of one into the asset of the other. 

The figures show the initial balance sheet extension for both parties: plus 50 billion on the left, minus 50 billion on the right. The net assets stay exactly the same before and after the bookings. For the central bank, the balance sheet extension remains in place until the government bond has been paid back (or the central bank sells the government bond off to the banking sector). Then the balance sheet is shortened again. In the case of the government, the balance sheet extension is only a snapshot since the new money on the assets side will soon be transferred to the recipients of the government spending. The money, translated by the banks, will become income and savings in the accounts of citizens and companies and circulate in the real economy. 

On the government balance sheet remains the new debt of 50 billion Canadian dollars that the government now owes to its own central bank – or to the banks to which the government bonds were resold in the meantime. For it is likely that the Canadian central bank will resell the government bonds so that they can perform their function as a “money sponge” within the banking system. 

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