Central Bank Balance Sheets: Expansion and Reduction Since 1900

Abstract

In this paper we study the evolution of central banks’ balance sheets in twelve advanced economies since 1900. We present a new dataset assembled from a wide array of historical sources. We find that balance sheet size in most developed countries has fluctuated within rather clearly defined bands relative to output. Historically, clusters of big expansions and contractions of balance sheets have been associated with periods of geopolitical or financial crisis. This explains the co-movement between the size of central bank balance sheets and public debt levels in the past century. The biggest of these crises, in terms of the impact on central bank balance sheets, were World War II and the global financial crisis. We show that large balance sheet expansions have on average taken a long time to unwind. Central banks have rarely reduced the size of their balance sheets in nominal terms. Reductions are predominantly achieved relative to output by holding nominal positions stable for long periods. On the basis of the historical evidence presented here, there are good reasons to expect the contraction of central bank balance sheets in our time to be slow and to take place relative to GDP rather than nominally. Relative to the size of the financial sector, moreover, central bank balance sheets had shrunk dramatically in the three decades preceding the global financial crisis. By that yardstick, their recent expansion partly marks a return to earlier levels. Some of the recent increase could therefore prove to be permanent if the financial sector maintains permanently higher liquidity ratios. The link between central bank balance sheet growth and inflation has loosened considerably in most advanced economies since 1980 and the inflation risks from the recent balance sheet expansion appear limited in the near term. However, we also note that large-scale purchases of government bonds have implications for public finance, even when debt management is not the primary objective of the purchases, because depressing bond yields reduces government debt service costs, especially when the public debt is relatively high. Fiscal considerations may well be adduced as another reason for proceeding cautiously with balance sheet reduction. History suggests that the threat to long run price stability is a real if slow-acting one when fiscal deficits persist and central bank independence is compromised. 뀀ഀȠ뀀ഀȠ뀀ഀȠ뀀ഀȠ뀀ഀȠ뀀ഀȠ뀀ഀȠ뀀ഀȠ뀀ഀȠ