Decomposition of High Power Money

Decomposition or sources of high-power money (H) with the help of the balance sheet identity of the central bank.

High-power money (H) is the currency (notes, coins) produced by the central bank that consists of the currency (C) held by people in their hands or pockets, total cash reserve (R) of BFIs and other deposits of government, government enterprises and  foreign offices (OD) with the central bank. 

NFAR=Total BOP Surplus -FA

i.e. H = C + R + OD

It is called high-powered money as on the basis of which all BFIs create money in the form of demand deposits (DD) under the credit creation process (CC).

There are many sources of (H) that can be decomposed with the help of the balance sheet identity of the central bank

i.e Total assets = Total liabilities

            ML + NML = FA + OPA

            ML = FA – NML + OPA

            ML = FA – (NML - OPA)

            ML = FA – NNML

Where,

ML = Monetary liabilities

NML = Non-monetary liabilities

OPA = other physical assets

FA = Financial assets

NNML = Net non-monetary liabilities

H = High-powered money or High power money

It shows that change in H depends upon the change in ML whereas change in ML depends upon either change in FA or change in NNML. Similarly, change in FA is determined by the change in total economic transactions of the central bank with five different sectors like foreign sector, government enterprises, BFIs and private sectors. So the change in FA depends upon the change in NFAR of the central bank, net credit to government, credit to the government enterprise, credit to the BFIs and credit to the private sector (specially its employee).

i.e FA = NFAR + NCG,  where, NFAR = net foreign assets reserves

Therefore, H = ML = FA – NNML

H = ML = NFAR + NCG + CAEs + CBIFs + CPS – NNML

a)      NFAR

The aggregate FAR of the central bank is the sum of gold, silver, foreign currencies foreign financial assets, SDRs (special drawing rights), {SDR is a account money for foreign transaction for special occasion} IMF reserve tranche position. The aggregate FAR of central bank is directly and positively related to the position of balance payment but a part of surplus BOP might be held by BFIs in their foreign transactions so the,

Hence, as NFAR held by the central bank increases monetary liability of central bank increases and thereby enhance high-powered money.

b) NCG

c) CGEs: central bank provides loan to the government enterprises, enterprises are divided into different group. Enterprises are financial one and they get loan directly from central bank and others from commercial bank as, (CGE increase = > MC increase = > H increase )

d) CBF is loan as a bank of the bank i.e. increase in CBFIs = > H

e) CPS: specially to its employees, home loan of total salary of 13 years or 18 lakhs, special loan 1200000 at 1%, vehicle loan/ auto loan 500000, welfare loan 100000, i.e. as CPS increases = > H increases

f) NNML is difference between NML and total monetary value of other physical assets

NML consists of capital resources, employees, provident fund, pension fund, welfare fund, gold/silver and foreign currency equalization fund deposits of central bank with IMF with local currency.

Similarly, other physical assets consists of total monetary value of land, building, furniture, equipment’s, vehicle, non-monetary gold, non-monetary foreign currency and net credits (outstanding receiving – outstanding payments). So, if NNML increases with the more monetary liability OPA, MC of central bank decreases and thereby squeezed H.

If NNMC decreases with less NML over OPL, MC of the central bank increases thereby enhance H. Therefore, money supply and also the size of H isn’t exogenously determined by the central bank. It is the combined economic behavior of central bank, government, government enterprises and also the private sector.

 Source: Arjun Panthee