What is the proper balance sheet recognition of money?

Money is a a financial asset issued by the central bank. Like any financial asset it may be recognized as an asset or a liability of issuer.

If the money issued is a promise to pay a certain amount of a commodity such as gold then the money should be recognized as a liability. In a fiat money system there is no promise to pay anything to holder of money so it generally should not be a liability. If money is issued to the people who are the central bank’s constituent it should be recognized as a form of equity.

Recognizing money as equity is beneficial in the sense that the central bank can print money in accordance to its targets without the balance sheet going negative. If money is a liability issuance of money increases a bank’s liabilities. In order to offset this the central bank expands money through asset purchases. Under an equity money system the bank can operate tools such as e-money heli-drops without needing to purchases assets which simplifies policy-making.

The issue of money backing arises if no assets are being purchased when expanding money. Credibility of issuer in terms of competence and accountability are the true backing of money. In event of collapse central bank assets like gold should not be accessible anyway to money holders so any physical backing is questionable. Under current fiat system one possible backing is the financial assets such as government bonds the CB purchases when conducting monetary policy. This is a dubious backing anyway because government bonds or similar instruments are claims on the money the central bank can print without limit. The monetary authority may continue to hold assets such as gold on its balance sheet but further issuance of money should generally not require an expansion of central bank asset purchases.

Balance sheet issues may arise if the central bank wishes to retract money through issuance of liabilities such as reverse repo, interest on reserves or bonds. This can easily be overcome by printing money and placing it on balance sheet of bank in an equal amount to its issued liabilities so that the balance sheet equals out.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s