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|
. |
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. |
. |
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gold |
deposits of Bank A deposits of Bank B |
government securities deposits at central bank paper money |
savings accounts other |
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.
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government securities deposits at central bank paper money
|
savings accounts other
|
paper money government securities |
net worth |
The table above has balance sheets of the main players in our story: a central bank, commercial banks, and the public. You should notice that almost everything that is in the liability column of a balance sheet has an equivalent entry in an asset column of a different balance sheet because what one person owes, another person owns. For example, the checking and savings accounts that are liabilities of commercial banks appear on the public's balance sheet as the asset "deposits at banks." Any debt, which is a liability to the person who owes the money, is an asset to the person to whom the money is owed.
The commercial banks have some assets, such as loans and government securities, that earn interest. Both securities and loans are debt owed to the bank. Loans are usually debt contracts that the bank has negotiated directly with the borrower, while securities are debt contracts that the bank buys without negotiating the terms of the contract. The bank has other assets, such as deposits at the central bank and paper money held in its vaults.2 In the past these assets earned no interest and there wass a costforegone interestto holding these non-interest bearing assets. A bank must hold some because it must stand ready to pay depositors who want to exchange deposits for cash. However, modern banks have another reason to hold these assets. Governments, usually acting through their central banks, have laws and regulations that establish the amount of these assets that a bank must have. We will call these required assets legal reserves, or bank reserves, or simply reserves.
2 Notice that these items have replace the gold that was on the balance sheets of the goldsmith bankers. To make our story more complicated, the deposits at the central bank can earn interest, as they do currently in the U.S. In its efforts to deal with the financial panic in the fall of 2008, the Fed obtained authority to pay interest on these deposits and began to do so in October, 2008.