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
1. 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.

1

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.
2
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.