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But that last bit, about taking the form of electrons, is important.

Too many people assume it must take some tangible form, like paper.

Bill: Yep. And I just did a last-minute edit to add "or electrons" where I said the Bank of Montreal cannot issue irredeemable bits of paper (or electrons) and get people to use them as money. Simply because I didn't want people to get hung up on the idea that it is illegal for the Bank of Montreal to issue *redeemable* bits of paper that come too close to currency.

So are you saying central banks have a monopoly over currency and central bank reserves?

The Bank of Canada has a monopoly on Bank of Canada liabilities. The Bank of Montreal has a monopoly on Bank of Montreal liabilities. Nick Rowe has a monopoly on Nick Rowe liabilities. That's not what makes the Bank of Canada special. No, I'm not saying that.

I just remembered. Back on the I=S post, IIRC, some people were complaining I didn't talk about banks enough. OK, here's a post on banks.

If you want to understand what the Swiss and Japanese are doing, and why the Japanese have been able to withstand at times a seemingly infinite influx of capital without their exchange rate going to the moon, understand what Nick is talking about.

(And understand that the CAD-USD peg he's talking about in a theoretical sense is not impossible in reality in certain circumstances. Ask the Swiss, and ask what Flaherty what the last 2 paragraphs of the most recent G7 press release were all about.)

"The Bank of Montreal cannot issue irredeemable bits of paper"

It has been the case in the past where banks did issue notes used as currency, before a central bank was formed. These days BMO et al aren't allowed to issue notes. I, on the other hand, can issue IOUs, as my friends will attest. I'm good for them; trust me! :)

jesse: but your notes are redeemable. And they (probably) don't get used as money. In the olden days, when BMO was allowed to issue notes, they were redeemable (in gold? indirectly?).

"there's this utterly bizarre belief among many economists that it is the Bank of Canada that has the power to set Canadian interest rates, just by borrowing and lending. . . .

"There is something very seriously wrong with any approach to monetary theory which says we can assume central banks set interest rates and ignore currency."

Hmmm. It sort of sounds like you have some approach to monetary theory in mind. ;)

All true but what follows from this? The Bank of Canada does set interest rates because it can borrow (from itself) at zero interest. The Bank of Montreal does not have this power. It has the right to say it will only borrow at a rate of zero, but it won't get any money in normal times.
Since we do not live in normal times and since central banks not only borrow in perpetuity from themselves at zero but lend at pretty much the same rate we are seeing the re-emergence in some currencies of cloakroom banking, where Swiss banks will charge you for the privilege of having them store your money. Obviously people would prefer to leave cash with the SNB rather than UBS or Credit Suisse, but the banking system has monopoly access to the central bank so that option is not open.
What I'm not clear about in your argument is whether you are saying there is any currency constraint on interest rates in a country which genuinely doesn't care what happens to the exchange rate.

"And the Bank of Canada would just call security if I tried to redeem it there."

Depends on who you are, I guess.

According to legend the line "I'll be back" might work wonders...

“The Bank of Montreal can refuse my request to open an account to convert my $100 Bank of Canada liability into a $100 Bank of Montreal liability. It is not obliged to redeem my money.”

That’s interesting.

On what basis could a Canadian chartered bank (or all Canadian chartered banks) refuse to open an account for somebody with Bank of Canada currency?

I.e. what unique basis other than that which might already preclude that same person from having an existing account with a Canadian chartered bank, from which to redeem into Bank of Canada currency?

Min: "Hmmm. It sort of sounds like you have some approach to monetary theory in mind. ;)"

I was asking myself the same question, after I had posted this. The *immediate* impetus for this post was some comments on my previous post. The Neo-Wicksellian approach of Woodford's "cashless" economy comes to mind, along with others. But I think the view I am opposing here is wider than any particular school. It might be better to ask the opposite question: which approaches *don't* say this?

Daphne: "What I'm not clear about in your argument is whether you are saying there is any currency constraint on interest rates in a country which genuinely doesn't care what happens to the exchange rate."

A country that doesn't care about its exchange rate can do *almost* anything it likes with monetary policy. If it does anything *too* outrageously wild people will stop accepting its irredeemable currency, resorting to another currency, or even barter. And it can't set real interest rates (or any real variable) in the long run.

JB: Good find! (Click on JB's name for the link.)

JKH: I don't think there's anything unique about it. If you come to me with a $100 Bank of Canada note and ask me to convert it into Nick Rowe dollars, I can just say "no". So can BMO. It can close all its branches and stop accepting deposits tomorrow if it feels like it. Usually, of course, it will accept your Bank of Canada dollars. Every business (in Canada) usually will. Bank of Canada dollars are the medium of exchange in Canada. We all choose to accept them, because we believe that everyone else will accept them from us. But we accept them on our own terms. Nobody can force me to sell my house, car, or services as an economist, for Bank of Canada Dollars, or anything else. But the Bank of Montreal is obliged to sell Bank of Montreal dollars for Bank of Canada dollars, at a fixed exchange rate (par).

Curses! That last sentence should read: But the Bank of Montreal is obliged to *buy* Bank of Montreal dollars for Bank of Canada dollars, at a fixed exchange rate (par).


My point was that any reason for BMO to refuse to accept BoC currency for one of its own liabilities would be a reason for BMO not to allow the same person a deposit account in the first place – e.g. a drug smuggler. So the exchange of a BMO deposit liability for BoC currency is moot in that case. It won’t sell BMO dollars for BoC dollars because it will already have refused to issue BMO dollars in the first place. It’s a symmetric result in that regard.

Conversely, anybody with an account through which BMO will redeem BoC dollars for BMO dollars is somebody for whom BMO will redeem BMO dollars for BoC dollars.

Once the account and the customer relationship are established, the redemption obligation is symmetric.

If/when the redemption obligation becomes asymmetric, the account has already been extinguished with respect to activity in either direction.

The chartered banks are distribution agents for BoC currency. The banks are responsible for the account creation and the account relationship, which is symmetric in the case of currency exchanges.

I suspect this gets complicated in a very unimportant way if we introduce private banks that can issue notes & coin, but which are restricted by the central bank (i.e. certain Scottish and Ulster banks).

It gets interested in a very interesting way if we assume these private banks (or indeed all private banks) can issue notes & coin without restriction, as in the 18th century. And, at that point, I defer to White & Selgin.


If you have a deposit account with BMO, BMO will definitely redeem your BoC currency for balances in that account - i.e. for BMO money.

If you don’t have a deposit account with BMO, BMO will assess your application for a deposit account with BMO, and if approved (mostly likely on the spot), BMO will redeem your currency for balances in your new account.

If you don’t have a deposit account with BMO, and BMO refuses your application for one (e.g. you are a drug smuggler), you won’t be able to redeem your currency for balances in a new account. And neither will you ever be in a position to redeem BMO money for currency, because you’ll never have balances in a BMO deposit account. So any potential asymmetry is moot. You can’t deal with BMO in either direction as far as currency conversion is concerned. It’s symmetric.

And if BMO literally shuts its doors as in your example, the idea of redeeming currency for BMO money is moot, because BMO for all intents and purposes is no longer a chartered bank. Moreover, existing deposit accounts will be paid out by CDIC - and almost certainly not in currency.


You’ve referred to two different types of redemption asymmetry.

One is with respect to the liability scope of the “redemption agent”. I obviously agree that the Bank of Canada doesn’t redeem its own liabilities for BMO liabilities, but BMO does redeem its own liabilities for Band of Canada liabilities.

The other is with respect to the directional scope of the “redemption agent”. Here, I disagree. The directional scope of BMO as redemption agent for Bank of Canada currency is symmetric, as I described.

The difference between the two symmetries is rooted in the fact that the chartered banks are distribution agents for Bank of Canada currency. That is the intended asymmetric institutional configuration, reflecting chartered banks as an extension of the central bank. An alternative would be a fully nationalized system where the existing chartered banks are subsumed as branch systems within a single national bank. In that case, currency redemption remains directionally symmetric. And the Bank of Canada (the only bank) sets all rates.

"And yet there's this utterly bizarre belief among many economists that it is the Bank of Canada that has the power to set Canadian interest rates, just by borrowing and lending. And that the Bank of Montreal, and ordinary people like me, somehow lack this special power."

Where does this come from Nick? What motivated this post?

You say there are economists out there that believe BMO doesn't set its own mortgage rates, or its own deposit rates, or its own prime rate?

Must be the same ones that believe the Bank of Canada doesn't set the Bank Rate.

"It is precisely those irredeemable monetary liabilities of the central bank (whether they take the physical form of paper, coin, electrons, does not matter) that give central banks their special power. That's what makes central banks central."

The central bank will redeem bank reserve deposits for currency and vice versa.

That's what enables the chartered banks to be distribution agents for currency.


By virtue of not redeeming deposits, the Bank of Canada has no liquidity risk on its balance sheet. When it buys securities from the private sector, it therefore "cancels" liquidity risk. This is not true of other types of portfolio risk. When it buys term bonds from an insurance company, for instance, it reduces that company's portfolio duration risk; it also increases the duration risk of the Canadian treasury (assuming BOC profits are remitted there) and that treasury passes on the risk to private actors. The same is true of earnings volatility (credit and equity) risk.

There may be signalling effects to buying interest bearing, credit, equity or any other securities, but other than that, doing so will only change the private sector's aggregate liquidity risk. When this risk is a large component of portfolio risk (i.e. during financial crises), this has a large influence on private sector portfolio allocations. In normal times, the effect would be small as liquidity risk is the smallest component of aggregate portfolio risk.


In the 1800's, private banks suspended convertibility of their notes several times. I don't know, but I expect that several private banks must have issued dollars that promised redemption in the dollars issued by another bank. Neither of these things is a defining feature of a central bank.

Actually, I can't come up with a single feature of central banks that sets them apart from regular banks. They are just bigger, that's all.

Mike Sproul,

A CB has non-redeemability without consequences. Clearinghouses in the 1800's could get away with temporary forced deposit maturity extensions. Look at what happens when those maturity extensions are more severe: I found data for Argentina and Chile in the early 90's after an Arg. banking crisis. The Argentine deposit-to-gdp ratio fell to 9%; Chile's was 50%. I assume something like this happened in 2001 as well.

It’s worth mentioning that the REASON central bank irredeemable money is accepted and used is that the relevant country’s tax authorities require taxes to be paid in central bank money: else you go to prison. Which is a fairly persuasive reason.


Private banks suspend redeemability every night and every weekend without consequences. Sometimes suspension lasts mont