THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 441
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CHAPTER 16
The Money Supply Process
409
To understand what
happens when there is an open market purchase from the nonbank public, we
must look at two cases. First, let s assume that the person or corporation that sells
the $100 of bonds to the Bank of Canada deposits the Bank s cheque in the local
bank. The nonbank public s T-account after this transaction is
OPEN MARKET PURCHASE FROM THE NONBANK PUBLIC
Nonbank Public
Assets
Securities
Chequable deposits
Liabilities
+$100
*$100
When the bank receives the cheque, it credits the depositor s account with the
$100 and then deposits the cheque in its account with the Bank of Canada, thereby
increasing its settlement balances and adding to its reserves. The banking system s
T-account becomes
Banking System
Assets
Reserves
Liabilities
*$100
Chequable deposits
*$100
The effect on the Bank of Canada s balance sheet is that it has gained $100 of
securities in its assets column, while it has an increase of $100 of settlement balances in its liabilities column:
Bank of Canada
Assets
Securities
Liabilities
*$100
Settlement balances
*$100
As you can see in the previous T-account, when the Bank of Canada s cheque
is deposited in a bank, the net result of the Bank of Canada s open market purchase
from the nonbank public is identical to the effect of its open market purchase from
a bank. Reserves increase by the amount of the open market purchase, and the
monetary base increases by the same amount.
If, however, the person or corporation selling the bonds to the Bank of Canada
cashes the Bank s cheque at a local bank, the effect on reserves is different.6
6
If the bond seller cashes the cheque at the local bank, its balance sheet will be unaffected because
the $100 of vault cash that it pays out will be exactly matched by the deposit of the $100 cheque at the
Bank of Canada. Thus its reserves will remain the same, and there will be no effect on its T-account.
That is why a T-account for the banking system does not appear here.
