Wednesday 28 October -- notes on banking:
Commercial Bank -- "T - Account"
|
Assets [What own] |
Liabilities [What owe] |
|
Reserves Loans Other [e.g. building] |
Deposits, i.e. checking accounts Other Equity |
Reserves are currency ["vault cash"] plus deposits with the Federal Reserve; "Required Reserves" are some percentage of "eligible liabilities," i.e. deposits.
"Excess Reserves" are Reserves minus Required Reserves.
Excess Reserves earn no income for the bank; therefore the bank will tend to convert them into income-earning assets, e.g. loans.
The Federal Reserve System -- "Central Bank"
Issues US currency [look at a dollar bill];
Serves as a bank for the commercial banks:
|
Assets |
Liabilities |
|
Government Securities (bonds) Gold Other (e.g. buildings, eqpt) |
Currency in circulation Bank deposits (reserves to them) Other (e.g. employee checking accounts) |
US currency is an IOU issued by the Fed. Reserves are IOU's (liabilities) of the Fed.
So what happens if the Fed buys some bonds from, e.g., an insurance company?
The bonds go into the asset side of the Fed's balance sheet; the Fed pays by writing a check, which the insurance company deposits in its checking account with a commercial bank. The commercial bank sends that to the Fed, and the commercial bank's reserves (the balance in it's account with the Fed) increase, on the liabilities side of the Fed's balance sheet.
Thus, but buying bonds, for which it pays with IOU's, the Fed increases the reserves available (in) the banking system; by selling bonds, it reduces them (when the buyer pays the Fed for the bonds, reserves disappear as the buyer's bank's reserves with the Fed decrease by the amount the buyer pays for the bonds).
Note that these open market operations involve the Fed buying or selling existing bonds from the non-bank public. It has nothing to do with the Government issuing new debt, running a deficit, or borrowing: when that happens, it is the US Treasury that sells NEW bonds, not existing ones, to the public.