Money Creation (Central Bank)

1. Divisions of the Economy (According to International Standards):

o Central Bank (CB): Responsible for issuing currency.
o Treasury: Issues coins.
o Depository Institutions (Banking Sector): Responsible for creating bank money,
primarily through lending and deposits.
o Non-Bank Public: Includes individuals, corporations, and non-banking financial
institutions (e.g., Islamic banks, investment banks, development banks).
2. Central Bank Money as a Liability:
o Money created by the central bank is considered a liability for the CB.
o For all other sectors (such as individuals and corporations), money is an asset.
o To increase the money supply (i.e., increase liabilities), the CB must:
▪ Decrease another item on the liability side.
▪ Increase an item on the asset side.

Central Bank (CB) Balance Sheet

• The CB balance sheet includes several critical components, especially assets and liabilities. A
simplified structure includes:
o Foreign Assets (FA): Assets held by the central bank in foreign currencies or foreign
reserves.
o Foreign Exchange (FX) Liabilities: Obligations owed in foreign currencies.
o Domestic Assets: Loans or credits provided within the domestic economy.
o Central Bank Money: Total liabilities in the local currency (e.g., TL in Turkey) that
include currency in circulation and reserves held by banks.
• FX Position Calculation:
o FX Position = Foreign Assets (FA) - Foreign Exchange Liabilities (FX liabilities).
o For example, if the CB borrows $1 to provide TL credit, the FX position could result in
a short position if there is an impending devaluation.

Valuation Account

• The valuation account reflects changes in the value of assets and liabilities due to currency
exchange rate fluctuations.
• Example:
o Suppose the central bank borrows $1 to provide credit in TL, and a major devaluation
happens (e.g., from 1$=10 TL to 1$=100 TL).
o The valuation account records the impact of this devaluation, showing a potential loss
or adjustment in CB liabilities.

Components of CB Money

1. Central Bank Money (TL Liabilities):

o All liabilities denominated in the local currency (TL) are part of CB Money, not just the
currency in circulation.
2. Breakdown of CB Money:
o Reserve Money: Consists of:
▪ Currency Issued and Circulating: Physical currency held by the public.
▪ Bank Reserves: Deposits that commercial banks hold at the central bank,
which include:
▪ Required Reserves: The minimum reserves banks must hold.
▪ Free Reserves: Any additional reserves beyond the requirement.
o Other CB Money: Includes components like:
▪ Open Market Operations (OMO): Tools used to manage liquidity in the
economy.
▪ Public Deposits: Deposits held by the government or other public entities.

Money Creation (Banking Sector and Public)

1. Definition of Money:
 o Money is defined as anything that serves as a medium of exchange and can be
easily converted without loss.
o Different types of money are classified into various aggregates (e.g., M1, M2, M2Y)
depending on their liquidity and the sector they belong to.
2. Money Aggregates:
o M1: Includes cash in circulation and demand deposits (such as checking accounts).
o M2: Adds time deposits (fixed savings accounts) to M1, increasing the measure of
money supply by including less liquid assets.
o M2Y: Expands M2 by including foreign currency deposits held by residents, providing
a broader view of the money supply within the economy.
For money to be included in these aggregates, it must belong to the non-bank public (individuals,
corporations, etc.).

Money Creation Process

1. Initial Credit Creation:

o When the Treasury needs funds, the central bank may extend credit to the Treasury.
o Example: Treasury receives +100 in local currency (e.g., TL) to pay salaries, and this
amount is credited to an individual’s (Metin's) checking account in Bank 1.
2. Reserve Requirements:
o Banks are required to hold a fraction of deposits as reserves with the central bank.
For example, Bank 1 deposits 20% of Metin’s +100 in the central bank as required
reserves.
3. Subsequent Lending:
o Banks lend out the remaining balance after setting aside reserves. For instance, Bank
1 extends credit of 80 units to Ahmet, which increases the money supply through
lending.
4. Spending and Further Deposits:
o Ahmet uses the 80 units to purchase a car, and the car dealer deposits this amount in
Bank 2, where 20% of it is again set aside as reserves.
o Bank 2 can then extend further credit, for example, to Ali, who opens a time deposit
and a foreign exchange (FX) account in Bank 3.
5. Money Multiplier Effect:
o This cycle of depositing, reserving, and lending creates a multiplier effect, where the
initial injection of money by the central bank leads to a larger increase in the total
money supply in the economy.
o M1 and M2 increase as money moves through the system via deposits and loans,
expanding the overall money supply available for transactions.

Money Supply Dynamics and GDP

1. Money Multiplier:
o Central Bank Money (CBM) multiplied by the money multiplier gives M2, an
important measure of the money supply.
2. Velocity of Money:
o M2, when multiplied by the velocity of money (the rate at which money circulates in
the economy), gives Nominal GDP (Gross Domestic Product).
o Nominal GDP is a key indicator of economic activity and is composed of inflation and
real output.

Summary of Key Transactions

• Credit to Treasury: Central bank provides funds to the Treasury, which pays salaries.
• Deposits in Banks: Individuals and businesses deposit this money into banks, where a
portion is held as reserves.
• Lending and Re-Lending: Banks lend out remaining funds, which circulate back into the
economy as new deposits, facilitating further lending.
• Reserve Requirements: Each bank must fulfill reserve requirements, limiting the amount that
can be re-lent but also controlling excessive money creation.
Tools of the Central Bank
Central banks use several primary tools to regulate the money supply, control inflation, and stabilize
the economy. These tools include Open Market Operations, Discount Loans, and Reserve
Requirements.

Open Market Operations (OMO)

1. Definition:
o Open Market Operations involve the buying and selling of government securities by
the central bank to control liquidity in the economy.
2. Characteristics:
o OMOs provide the central bank with complete control over the money supply, are
flexible and precise, can be easily reversed, and can be implemented quickly.
3. Types of Open Market Operations:
o Outright Purchase and Sale:
▪ Outright Purchase: The central bank buys government securities, increasing
money available in the market, which typically lowers interest rates and
increases liquidity.
▪ Outright Sale: The central bank sells government securities, reducing money
in circulation, increasing interest rates, and absorbing excess liquidity
permanently.
o Repurchase Agreement (Repo):
▪ A repo involves the sale of securities with an agreement to repurchase them
at a future date, temporarily injecting liquidity.
▪ Reverse Repo: The central bank sells securities with an agreement to
repurchase them, temporarily removing liquidity from the market.
4. Primary vs. Secondary Market:
o The central bank purchases securities from the secondary market (not directly from
the Treasury) to avoid direct financing of the government, adhering to regulatory
requirements.
5. Operational Strategy:
o When liquidity is tight: The central bank can engage in a permanent outright
purchase or a repo transaction.
o To absorb excess liquidity: It conducts a permanent outright sale or a reverse repo
transaction.

Discount Loans
1. Purpose:
o Discount loans are loans provided by the central bank to commercial banks to help
them manage short-term liquidity needs.
2. Types of Discount Loans:
o Adjustment Credit Loans: For short-term liquidity problems due to temporary deposit
outflows.
o Seasonal Credit: To assist banks in regions with seasonal financial needs, such as
agricultural areas.
o Extended Credit: For banks experiencing significant liquidity issues due to major
deposit outflows.
3. Lender of Last Resort Function:
o The central bank acts as a lender of last resort to prevent banking panics and financial
crises.
o Risks: Discount loans are usually provided below market rates, so frequent use by a
bank may lead to increased scrutiny from the central bank.
4. Signaling Effect:
o An increase in the discount rate signals a tightening of monetary policy, but this can
be misinterpreted by the market, especially if it diverges from other interest rates.

Reserve Requirements
1. Definition:
o Reserve requirements dictate the minimum reserves a bank must hold against
deposits, directly impacting the money supply.
 2. Advantages:
o Powerful Impact: Reserve requirements affect all banks equally and have a
significant effect on the money supply.
3. Disadvantages:
o Sharp Changes in Money Supply: Even small adjustments can lead to substantial
changes, making it difficult for fine-tuning.
o Liquidity Challenges for Banks: Increasing requirements can strain banks with low
excess reserves.
o Uncertainty: Frequent changes create uncertainty for banks in managing liquidity,
which is why changes in reserve requirements are rare.

Central Bank Transactions and Liquidity

1. Impact on International Reserves and CB Money:
o When the central bank sells foreign assets (e.g., selling foreign currency to buy
domestic currency), both its international reserves and CB Money (money supply)
decrease.
o Conversely, when the central bank buys foreign assets (e.g., purchasing foreign
currency with domestic currency), its international reserves and CB Money increase.

FX Market Interventions
1. Purpose of Interventions:
o Central banks intervene in the foreign exchange (FX) market to influence exchange
rates by buying or selling currencies.
o Unsterilized FX Intervention: Any FX intervention affecting the central bank’s
balance sheet, thereby impacting the money supply, is considered unsterilized.
2. Case Studies of FX Intervention:
o Case 1: FX Sale (Reducing Money Supply):
▪ When the central bank sells foreign assets, it reduces TL (Turkish Lira)
availability, leading to:
▪ A decrease in international reserves.
▪ A decrease in the money supply.
▪ Appreciation of the domestic currency due to reduced TL in
circulation.
o Case 2: FX Purchase (Increasing Money Supply):
▪ When the central bank purchases foreign assets with domestic currency, it
increases both international reserves and CB Money, potentially leading to TL
depreciation in the long run.

Effects of FX Intervention on Exchange Rates

• Currency Appreciation:
o Selling foreign assets tends to appreciate the domestic currency as the supply of
domestic currency decreases, which can increase its value relative to foreign
currencies.
o Appreciation also follows when Turkish goods become cheaper, driving up demand for
TL and increasing the returns on TL relative to foreign currencies.
• Currency Depreciation:
o Purchasing foreign assets increases the money supply, leading to depreciation of TL
in the long run, as more domestic currency is available.

Sterilized Intervention
1. Definition and Purpose:
o In a sterilized intervention, the central bank conducts offsetting open market
operations to neutralize the impact on the monetary base (total currency in circulation,
reserves, and OMO).
o Monetary Base Calculation:
▪ Includes currency issued, required and free reserves, funds, non-bank
deposits, and OMO, which together determine CB Money.
2. Exchange Rate Effects:
 o In ideal conditions, if the expected returns on domestic and foreign deposits are equal,
no exchange rate movement is expected.
o Capital Controls: Restrictions like capital controls can lead to imbalances, causing
differences in expected returns between domestic and foreign deposits, introducing
exchange rate risk.
3. Studies on Sterilized Intervention:
o Economists find that sterilized interventions generally have minimal impact on FX
rates due to the limited effect on overall liquidity.

Basics of the Foreign Exchange Market

1. Exchange Rate:
o The exchange rate is the price of one currency in terms of another.
o A currency’s appreciation (increase in value) makes foreign goods and travel cheaper
for its residents, while depreciation (decrease in value) makes them more expensive.
2. Effects of Depreciation and Appreciation:
o Depreciation: When a currency depreciates, exports become cheaper for foreign
buyers, increasing competitiveness abroad, but imports become more expensive
domestically.
o Appreciation: When a currency appreciates, exports become more expensive for
foreign buyers, reducing demand, while imports become cheaper domestically.

Short-Run Behavior of Exchange Rates

1. Asset Market Approach:
o Exchange rates in the short term are determined by decisions to hold domestic vs.
foreign assets rather than by import/export demand alone, as financial transactions
vastly outsize trade flows.
2. Interest Parity Condition:
o The relative expected return on domestic versus foreign deposits influences exchange
rates.
o If expected returns on domestic deposits exceed those on foreign deposits, investors
will prefer domestic assets, leading to currency appreciation.

Dollar/Euro Parity and Expected Returns

1. Expected Return on Dollar vs. Euro Deposits:
o Let i$ represent the interest rate on dollar deposits and ii€ for euro deposits.
o The expected rate of appreciation or depreciation of the dollar in terms of euros
affects the return on dollar deposits in euros.
o Formula for relative expected return:

• If the relative return on dollar deposits rises, demand for dollar deposits increases, leading to
dollar appreciation.
2. Equilibrium Condition:

• In equilibrium, relative expected return equals zero:

o When this condition is met, both domestic and foreign investors hold a balanced mix
of assets.

Factors Affecting Exchange Rate Equilibrium

1. Interest Rate Changes:
 o An increase in the euro interest rate (i€) causes demand for euros to rise, leading to
euro appreciation and dollar depreciation.
o Conversely, an increase in the dollar interest rate (i$) raises the dollar’s expected
return, causing it to appreciate.
2. Expected Future Exchange Rate ( Ee(t+1) ):
o If expectations for the future exchange rate suggest dollar appreciation, demand for
dollar deposits will rise, leading to an immediate appreciation of the dollar.
3. Other Influencing Factors:
o Expectations of higher U.S. price levels, lower tariffs, increased import demand,
reduced export demand, or lower productivity relative to foreign markets can lead to
dollar depreciation as foreign currency demand increases.

1. Definition:
o The Balance of Payments (BoP) records all international transactions of a country,
including inflows and outflows of goods, services, and monetary assets between
residents and non-residents.
o It follows a double-entry bookkeeping system, reflecting all payments impacting fund
movements between a nation and foreign countries.

Principles of BoP Accounting

1. Credits (Positive Entries):
o Transactions that bring foreign money into the country are recorded with a plus (+)
sign as credits, indicating receipts of foreign currency.
o Examples:
▪ Exports of goods and services (e.g., textiles).
▪ Foreign tourism revenues.
▪ Foreign investments in the country.
▪ Loans and physical investments by foreigners.
▪ Unilateral payments (e.g., remittances, foreign aid).
2. Debits (Negative Entries):
o Transactions that send foreign money out from residents to foreigners are recorded
with a minus (-) sign as debits.
o Examples:
▪ Imports of goods and services.
▪ Expenses by Turkish tourists abroad.
▪ Investments by Turkish residents in foreign countries (e.g., deposits in foreign
banks).

BoP Accounts Structure

1. Categories of BoP Accounts:
 o Current Account: Includes trade in goods and services, primary income (e.g.,
investment returns), and secondary income (e.g., transfers like foreign aid).
o Capital and Financial Accounts: Reflects capital transfers, foreign investments, and
financial assets and liabilities transactions.
o Change in Reserves: Central bank actions related to reserve assets to balance BoP,
along with net errors and omissions.
2. BoP Balancing Mechanism:
o Any current account surplus or deficit is offset by:
▪ Capital and financial account activities (borrowing or lending internationally).
▪ Adjustments in government reserve assets or through accounting for net
errors and omissions.

Current Account Balance (CAB)

1. Importance:
o The Current Account Balance (CAB) is closely monitored because it provides insight
into future exchange rate movements.
o A high demand for foreign goods (imports) can lead to depreciation of the local
currency (e.g., TL) as demand for foreign currency increases.
2. Current Account Deficit (CAD):
o Definition: CAD occurs when a country imports more goods and services than it
exports, resulting in a need for external financing.
o CAD reflects reliance on foreign savings, as domestic savings are insufficient to
cover the deficit.
o Twin Deficit: CAD often correlates with a fiscal deficit, where both public spending
exceeds revenue, and the current account is negative, increasing the need for foreign
capital.

Conceptual Relationships in BoP Accounts

1. Components of GNI and BoP:

• Net exports of goods and services are a key component of Gross National Income (GNI),
directly impacting production and employment levels within the economy.

• BoP equilibrium is achieved when:

1. Private and Fiscal Balances:

o The BoP also links the private sector balance (private savings minus private
investment) and the fiscal balance (government spending minus revenue).
o Together, these balances influence overall financial stability and the need for foreign
reserves or adjustments in exchange rates.
Balance of Payments (BoP) Equation
The Balance of Payments (BoP) summarizes a country's financial transactions with the rest of the
world and must ultimately balance to zero. The structure is:
1. BoP Equation:
o Current Account Balance
o Change in Reserve Assets (-) (central bank reserve changes that adjust for
surpluses or deficits)
o Financial Account Balance
o Net Errors and Omissions
o When combined, these components equal zero, balancing the BoP.

Components of the Financial Account

The Financial Account records net financial flows into and out of the country and includes:
1. Net Financial Inflows and Outflows:
o Measures the net movement of capital based on investments and loans.
2. Subcategories:
o Foreign Direct Investment (FDI): Long-term investments in physical assets like
factories or companies.
o Portfolio Investment: Investments in financial assets such as stocks and bonds,
often short-term and sensitive to interest rate changes.
o Loans: Borrowing and lending activities between countries.
o Other Investments: Other financial flows, which could include bank deposits, trade
credits, and other forms of capital movement.
3. Capital Account Balance:
o Records capital transfers and acquisitions/disposals of non-produced, non-financial
assets.

Turkey’s Balance of Payments (BoP)

1. Annual and Monthly BoP Data:
o The Central Bank of Turkey (CBRT) tracks annual and monthly BoP data, covering
components like the current account, financial account, and reserve assets. These
records indicate Turkey's trade balance, foreign investments, and capital flows,
helping to monitor economic stability.
2. Foreign Direct Investment (FDI):
o FDI data, sourced from TURKSTAT, shows the inflow of foreign capital into Turkey for
long-term investments in sectors like manufacturing, infrastructure, and real estate.
This is a key component of the financial account and reflects investor confidence in
Turkey’s economy.
Breakdown of Turkish Imports and Exports
1. Import Breakdown (Million USD):
o The distribution of imports over the years, categorized by various product groups,
highlights Turkey's dependency on foreign goods. This breakdown includes sectors
such as energy, machinery, and chemicals, providing insights into areas where Turkey
relies heavily on imports.
2. Export Breakdown (Million USD):
o Similarly, the export data shows Turkey’s export composition across years, detailing
key industries like automotive, textiles, and electronics. Exports are crucial for
generating foreign currency inflows and supporting the balance of payments.
3. Top Export Destinations and Import Partners:
o The top export destinations and import partners reveal Turkey’s key trading
relationships. Countries in Europe, the Middle East, and North America are significant
trading partners, influencing Turkey's trade policies and economic alliances.

Savings-Investment Gap
1. Turkey’s Savings-Investment Gap:
o The gap between national savings and investments is a crucial metric affecting the
current account balance. When domestic savings are insufficient to fund investments,
Turkey relies on foreign savings, leading to current account deficits (CAD). This gap
indicates how external financing supports Turkey’s economic growth but also exposes
it to foreign debt risks.
2. Current Account Balance and GDP Growth:
o Data shows the relationship between GDP growth, the current account balance, and
the savings-investment gap. High growth periods often coincide with a widening
savings-investment gap and higher CAD, requiring careful economic planning to avoid
excessive foreign debt accumulation.

Other Key Metrics

1. Export Unit Value Index:
o This index measures the average value per kilogram of exports, reflecting how
Turkey’s export value changes relative to volume. A higher index suggests increased
export value, which is beneficial for improving the trade balance.
2. Gross External Debt:
o Turkey’s gross external debt, tracked by the Ministry of Treasury and Finance,
indicates the level of foreign debt held by the public and private sectors. Managing
this debt is critical for maintaining financial stability and sustaining investor
confidence.

Types of Inflation
1. Hyperinflation:
o Hyperinflation is characterized by an extremely high and rapidly accelerating inflation
rate, often driven by events like war, civil unrest, or massive fiscal deficits financed by
printing money.
 o Historical examples include post-World War I Germany and more recent cases in
Bolivia (1985) due to political instability and debt crises.
2. Chronic Inflation:
o Chronic inflation persists over long periods (years rather than months) with moderate
intensity. It does not accelerate uncontrollably but remains persistently high.
o Countries like Argentina, Brazil, and Turkey (1987-2002) are examples, where
societies adapted to inflation by implementing indexation mechanisms.

Approaches to Curbing Hyperinflation

1. Exchange Rate as a Nominal Anchor:
o Stabilizing the exchange rate can help achieve price stability by indexing domestic
prices to a stable foreign currency (e.g., the U.S. dollar).
o Exchange rate stabilization can stop inflation abruptly, often at a relatively low
economic cost compared to chronic inflation scenarios, as seen in Greek stabilization
in 1946.
2. High Credibility and Urgency:
o High credibility of the stabilization program, often accompanied by fiscal reforms, is
essential.
o Hyperinflation creates a strong public demand for action, enhancing the program's
acceptance and effectiveness.

Methods to Combat Chronic Inflation

1. Stabilization Program Types:
o Populist Approach: Attempts to control prices and wages without addressing
underlying fiscal deficits, often failing (e.g., Chile in the early 1970s).
o Orthodox Program: Focuses on reducing budget deficits, slowing currency
depreciation, and controlling money supply.
o Heterodox Programs: Use short-term freezes on prices and wages, requiring broad
societal consensus (e.g., Argentina in 1985, Brazil in 1980, Israel in 1986).
2. Stabilization Program Methods:
o Exchange Rate-Based Stabilization: Slows the rate of currency devaluation, but
inertia in inflation can lead to a gradual decrease. This often results in real currency
appreciation and potential trade imbalances.
o Money-Based Stabilization: Controls the money supply growth, leading to upfront
economic contractions (e.g., recessions), as seen in Chile’s 1975 and Argentina’s
Bonex Plan in 1989.
o Multiple Anchors: Combines monetary, credit, and income policies. For instance,
Israel’s 1985 program included strict credit limits and tighter short-term capital controls
to combat inflation.

Policy Implications of Stabilization Programs

1. Fiscal Adjustment:
 o Fiscal reform is necessary but not enough for sustainable inflation control. Without
sound fiscal policy, stabilization efforts may fail.
2. Credibility and Public Confidence:
o High public confidence in the program is essential. Money-based strategies are better
for low-credibility environments, as exchange rate-based approaches risk failure if the
public doubts the program's sustainability.
o Credibility helps avoid the need for competitive real exchange rates, as real currency
appreciation typically follows stabilization efforts.
3. Use of Exchange Rate Anchors:
o In economies with a high degree of currency substitution, the exchange rate serves as
an effective anchor, but budget deficits must be controlled.

Public Budget Structure

1. Public Sector vs. General Government:
o The public sector includes all government-controlled institutions, categorized into:
▪ General Government: Comprises the central, state, and local governments
as well as social security funds.
▪ Public Corporations: Divided into financial (like the central bank) and non-
financial entities.
2. General Government:
o According to international standards (IMF GFSM 2017), general government includes:
▪ Central Government: Covers ministries and agencies directly funded by the
central budget.
▪ State Governments: Only in countries with federal systems.
▪ Local Governments: Municipalities and local councils.
▪ Social Security Funds: Separate funds for pensions, healthcare, etc.

Budget Types and Scope in Turkey

1. Central Government Budget:
o General Budget: For public institutions under direct government control.
o Special Budget: For institutions related to specific public services with their own
revenue streams (e.g., universities).
o Regulatory and Supervisory Agency Budget: For agencies with oversight functions
established by special laws (e.g., BDDK, SPK).
2. Other Budgets:
o Social Security Institutions Budget: Funds for public institutions providing social
security.
o Local Government Budget: For municipal administrations and related local entities.
o Extra-Budgetary Funds: Includes institutions outside the central government’s main
budget, such as social facilities or revolving funds.
Principles of Government Financial Statistics
1. Stock and Flow:
o Stock (Balance Sheet): Represents assets and liabilities at a specific time.
o Flow (Statement of Operations): Tracks revenue and expenditures over a period.
o Opening and closing balance sheets reflect changes due to operations and economic
flows (e.g., asset revaluation or debt reclassification).
2. Bases of Accounting:
o Accrual Basis: Records transactions when they are earned or incurred, not
necessarily when cash changes hands.
o Cash Basis: Records transactions upon actual cash receipt or payment, more
common for immediate financial control.

Budget Deficit Financing Methods

1. Domestic Borrowing: Increases public debt and may lead to higher interest rates.
2. Foreign Borrowing: Provides foreign currency inflow but increases exposure to exchange
rate risk.
3. Money Printing: May lead to inflation, as it increases money supply without a matching
increase in goods or services.
4. Using FX Reserves: Can help stabilize currency value but risks depleting reserves, leading to
a balance of payments crisis.

National Income Accounting Identity

1. National Income Equation:
o Y=C+I+G+(X−M)Y = C + I + G + (X - M)Y=C+I+G+(X−M), where:
▪ YYY = National Income
▪ CCC = Consumption
▪ III = Investment
▪ GGG = Government Expenditures
▪ X−MX - MX−M = Net Exports (Exports - Imports)
2. Savings-Investment Balance:
o S=I+(G−T)+(X−M)S = I + (G - T) + (X - M)S=I+(G−T)+(X−M)
o Private and public savings impact the current account balance. A higher savings rate
generally improves the current account, while higher government spending (budget
deficit) can lead to a current account deficit.

Open Market Operations (OMO) and Central Bank Money (CB Money)

1. Case 1: Conversion of Foreign Assets to CB Money:

o Suppose the non-bank public converts 80 units of non-TL (foreign currency)

denominated assets into TL assets, increasing CB Money by 80 units.
 o This transaction also raises Foreign Assets by 80 units in the Central Bank’s balance
sheet to maintain accounting identity.

2. Liquidity Implications:

o CB Money is the sum of Reserve Money (liquidity in the banking sector) and Other
CB Money (including OMO).

o To prevent excess liquidity (which could lead to inflation), the Central Bank has
options to control this increase:

▪ Option 1: Reflect the 80-unit increase in Reserve Money, which would

directly raise market liquidity.

▪ Option 2: Absorb liquidity by allocating the 80-unit increase to Open Market

Operations (OMO), specifically through Reverse Repos (temporarily
borrowing funds from the market to reduce liquidity).

3. Decision Implications:

o Option 1 might lead to inflationary pressure by increasing Reserve Money.

o Option 2 controls liquidity without changing Reserve Money by using reverse repo
transactions, thus maintaining stable liquidity levels in the banking sector.

Case 2: Sale of Domestic Assets to Reduce CB Money

1. Scenario:

o The Central Bank decides to sell 60 units of its fixed-income securities (bonds),
collecting 60 units of local currency (TL) in return.

o This reduces the Domestic Assets by 60 units and decreases CB Money by 60 units
as TL is removed from circulation.

2. Implications for Liquidity:

o Similar to Case 1, the Central Bank can manage this reduction in CB Money through
two options:

▪ Option 1: Reflect the 60-unit decrease in Reserve Money, reducing overall

liquidity in the market.

▪ Option 2: Utilize Repurchase Agreements (Repos) to temporarily inject

liquidity into the system, offsetting the decrease in CB Money without
impacting Reserve Money.

3. Policy Considerations:

o Option 1 would further reduce market liquidity, which may be undesirable in the
presence of deflationary pressures.

o Option 2 helps maintain stable liquidity by temporarily lending money through repo
agreements, effectively neutralizing the reduction in Reserve Money.