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The federal government raises 400 million by selling bonds to the general public in order to pay for a construction program. The program cost 440 million so the government withdraws 25 million from its Royal Bank deposits and 15 million from its Bank of Canada deposits. If the target reserve ration of the private banks if 10%, what is the change in private bank reserve?

I not sure what's going on. The answer is private bank reserve rise by 15 million, but all I see is that the money all cancels out. There might be a change in money supply because of the decreased deposits, but those still would not give a rise in 15 million. What am I not understanding?

EDIT: After some thought, I think it's because the 15 that was in the Bank of Canada in now deposited in private banks by the public, hence the 15 million increase.

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  • $\begingroup$ For those not Canadian, the "Bank of Canada" is the central bank, while the "Royal Bank of Canada" is the largest commercial bank $\endgroup$
    – Henry
    Aug 15 '16 at 23:47
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I can only offer you an explanation of what is four types of money in the United States context, in which my hope is you can understand what reserves are and how they work in the United States context at least.

Not knowing how your friend defines "currency" as opposed to money. All I can offer is that there are four different types of money issued in the United States.

  1. Coins - physical money created and issued by the U.S. Treasury and sold at face value to the Federal Reserve, which books coins as an asset on its balance sheet. Unlike the other three forms of money I will outline in this answer, coins are issued without any corresponding debt attached to them. Coins are legal tender, meaning that they can be used to pay, "all debts, public charges, taxes, and dues." 31 U.S.C. § 5103.
  2. Cash - aka, Federal Reserve Notes, is physical money issued by the Federal Reserve (though created by the Treasury's Bureau of Engraving and Printing at the Fed's instruction) and sold by the Fed at face value to commercial banks, which pay for cash using their reserve accounts at the Fed, which get debited in the amount of cash obtained. Cash is one of two liabilities on the Federal Reserve's balance sheet, and an obligation of the U.S. government. Cash is legal tender, meaning it can be used to pay, "all debts, public charges, taxes, and dues." 31 U.S.C. § 5103.
  3. Reserves - this is electronic money created and issued by the Federal Reserve in exchange for U.S. government bonds and bills, that is, IOUs from the U.S. government. Reserves are the second liability on the Federal Reserve's balance sheet, but reserves are assets to commercial banks and other entities that bank with the Fed, including the U.S. government and foreign central banks. Reserves, that is, Fed liabilities or IOUs, are money only for these entities, and exist only as the result of government debt. The amount of reserves in the system is controlled by the Federal Reserve, which increases reserves by buying government bonds or agency mortgage-backed securities and decreases reserves by selling government bonds or agency mortgage-backed securities. Reserves are not legal tender.
  4. Bank money - this electronic money created and issued by commercial banks in exchange for debt, public or private, taken by borrowers from the bank, whose electronic accounts at the bank are credited in the amount of their new loan. Bank money is a liability to commercial banks but is an asset to non-bank entities who bank at commercial banks, including people, non-financial businesses, non-bank financial businesses, and governments...bank money, that is, a commercial bank liability or IOU is money for these entities. The amount of bank money in the system is controlled by commercial banks, which increase bank money bu buying debt, crediting bank accounts in exchange for loan paper, and decrease bank money by not issuing new debt as old debt gets paid off. Bank money is not legal tender.

With all of the above said, reserves are an electronic form of money created and issued by the Federal Reserve or in your case, maybe the Bank of Canada in exchange for debt securities like U.S. Treasuries. Reserves are a liability on the Federal Reserve's balance sheet, with the corresponding asset typically being a government bond. Legally, reserves are IOUs from the Federal Reserve to any entity having an account at the Fed, into which reserves can be deposited. Ordinary people and businesses...even non-bank financial businesses...do not have accounts at the Federal Reserve. Reserves are thus not money for ordinary people and businesses, nor are they money for the Fed itself. Reserves serve as money only to account holders at the Federal Reserve, mainly commercial banks. As such, reserves are assets on the balance sheets of commercial banks and as noted above, liabilities to the Federal Reserve or the Bank of Canada.

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  • $\begingroup$ - 1 for not answering the question, sorry. $\endgroup$
    – BrsG
    Jul 26 at 10:23

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