Central Bank Balance Sheet Research Articles

Liquidity Shocks and The Bank Lending Channel: Evidence from Lower-Middle Income Economies

This paper examines the impacts of central banks’ liquidity injections on commercial banks’ credit supply in thirty-two lower-middle income economies over the period 1990 until 2020. We use a SVAR panel model to analyze the dynamic interactions between the central bank balance sheet policy, bank liquidity, and bank lending. The results show that liquidity injections have a non-significant impact on the credit to the private sector and a persistent positive impact on banks’ liquid reserves. These results confirm the inefficiency of the bank lending channel in transmitting the central bank balance sheet monetary policy to the real economy in the considered LMIC’s.

Normalizing the Central Bank's Balance Sheet: Implications for Inflation and Debt Dynamics

AbstractWe explore the effects of reducing the overall size of the central bank's balance sheet and lowering its maturity structure. To do so, we consider an environment where fiscal policy is traditionally passive and the central bank follows the Taylor principle. In addition, the monetary authority has also explicit size and compositional rules regarding its balance sheet. Agents in this economy face limited commitment in some markets and government bonds can be used as collateral. When short‐ and long‐term public debt exhibit premia, changes in the central bank's balance sheet have implications for long‐run inflation and real allocations. To ensure a unique locally stable steady state, the central bank should target a low enough maturity composition of its balance sheet. In our numerical exercise, calibrated to the United States, we find that long‐term debt holdings by the central bank should be less than 0.5 times of their short‐term positions. Moreover, the process of balance sheet normalization should aggressively respond to the total debt issued in the economy relative to its target. These findings depend on the degree of liquidity of long‐term bonds. The more liquid long‐term bonds are, the lower is the value of the composition threshold and the parameter space consistent with unique and stable equilibria is smaller. In addition, we consider a modified Taylor rule that takes into account the premium. Such a rule increases the prevalence of multiplicity of steady states and delivers lower welfare. Thus, we argue that the traditional Taylor rule is appropriate for managing interest rates in the presence of premia.

An investigation of the impacts of asset ratio policy on the banking system during the Covid-19 crisis in Turkey

PurposeThis paper provides a quantitative assessment of the “asset ratio” rule defined in Turkey as part of measures taken to stimulate the economy amid the Covid-19 pandemic. The main objective of the new rule was to boost credit growth in the economy and provide lending for credit-constrained households and firms that are in need. A secondary aim was to shift the denomination structure of the deposits toward domestic currency. Hence, the paper focus particularly on how the policy affected the growth rate of loans and the share of domestic deposits relative to foreign ones among the commercial banks. The policy was also heavily criticized due to the possibility that it will subjugate the banking system to excessive risk. The paper explore this possible impact by measuring how much the policy affected the default risk allowances in the banking system.Design/methodology/approachThe new policy required banks with deposits above a threshold level, i.e. large banks, to maintain a certain asset ratio. Banks with deposits below the threshold, i.e. small banks, were held exempt from it. The paper implement a difference-in difference methodology to assess the quantitative impacts of the asset ratio policy by taking large banks as the treatment group, and small banks as the control group.FindingsDifference-in-difference estimation results suggest that the asset ratio policy resulted in a 9.6% rise in loans and an 8.4% rise in government securities. Deposits also increased, with no significant change in their composition. The policy initially generated a 7% increase in the credit risk allowances of banks in the treatment group, which vanished in the following periods. Based on all these, the paper argue that the policy was successful in providing liquidity to the economy without jeopardizing the financial stability.Research limitations/implicationsThe findings of this study show that asset ratio policy is effective in increasing credit growth in countries with limited policy space such as Turkey. While saying this, the importance of the robust and prudent structure of the banking system in the economy should be underlined. Otherwise, the policy may have an unintended consequence of raising systemic risk. The policy suggestions also apply to advanced countries where the monetary policy has reached a natural limit due to the zero lower bound (ZLB). The ZLB problem encouraged these countries to use quantitative easing schemes in the aftermath of the Covid-19 crisis, just like the global financial crisis. However, it may take a long time to undo the effects of this policy on the balance sheets of central banks. In such cases, asset ratio policy can also be considered as an alternative tool for advanced economies notwithstanding the fact that the banking system should be prudent, well-capitalized and the country should have enough fiscal space. The main objective of the asset ratio policy was to help SMEs that were in urgent need of liquidity at the beginning of the crisis. The bank balance sheet data used in this paper does not contain information about the borrowers of the loans extended during the implementation of the policy. Analysis of this dimension using matched bank-firm level data will better demonstrate the success of the policy in achieving this goal. The paper address this as the main limitation of the paper and leave that analysis for future research.Originality/valueThis paper provides an important contribution to the literature by assessing a new unique policy whose objective is to stimulate loans and mitigate the impact of the Covid-19 crisis on the economy. The policy in question is predicted to have effects on the asset and liability structure and risk exposure of the banking system in Turkey. The quantitative analysis in this study estimates these impacts and discusses the effectiveness of the new policy in providing a relief for firms and households in need. Whether or not the policy caused a disruption in the sound structure of the banking system in Turkey is another question addressed in the paper.

Monetary policy in a world of radical uncertainty

Monetary policy in a world of radical uncertainty

Rate Forward Guidance in an Environment of Large Central Bank Balance Sheets: A Eurosystem Stock-Taking Assessment

Rate Forward Guidance in an Environment of Large Central Bank Balance Sheets: A Eurosystem Stock-Taking Assessment

Liquidity Dependence: Why Shrinking Central Bank Balance Sheets is an Uphill Task

Liquidity Dependence: Why Shrinking Central Bank Balance Sheets is an Uphill Task

Central bank collateral as a green monetary policy instrument

ABSTRACT Central banks can play an important role in the transition towards a climate-neutral economy. This paper discusses different green monetary policy instruments along the dimensions of feasibility of implementation and impact on the transition process. We identify the inclusion of ‘brown’ collateral haircuts into a central bank’s collateralized lending framework as the most promising conduit of green monetary policy. The impact of such interventions on the real economy is then formally explored by extending a general equilibrium transition model to include a simple banking sector with central bank lending facilities and collateral adjustments. We find that both ‘brown’ collateral haircuts and ‘green hairgrowth’ increase carbon neutral investment while decreasing carbon intensive investment and emissions. Consequently, in addition to decreasing the exposure of the central bank balance sheet to climate-related risks, climate-based collateral adjustments have the potential of increasing the political feasibility of a timely transition to a carbon neutral economy by affecting emission levels. Despite ‘green hairgrowth’ having a stronger effect on investment and emissions, ‘brown’ collateral haircuts remain the recommended policy as the former is not necessarily ‘market neutral’ and thus cannot be broadly applied across central banks. Key policy insights ‘Brown’ collateral constraints as green monetary policy is a feasible instrument that can be broadly implemented across different central bank frameworks and mandates. ‘Brown’ collateral haircuts increase the financing costs and decrease the volume of carbon intensive investments. ‘Green hairgrowth’ has a similar effect but is in conflict with market neutrality and, therefore, not as broadly implementable. The synergy of a price instrument and ‘brown’ collateral constraints results in a significantly lower and potentially politically more feasible carbon tax.

National states, transnational institutions, and hegemony in the EU

The institutional framework of the EU was altered by the pandemic shock of 2020, introducing greater discretion in both monetary and fiscal policy. The changes relate mostly to monetary policy and cast light on the theoretical debates regarding national states and transnational mechanisms in the EU. Some of the likely implications can be gauged through the balance sheet of the European Central Bank and the operations of the clearing mechanism of TARGET2. Fiscal policy was also transformed due to the threat posed by the pandemic for the euro, thus lifting the framework of austerity. It is notable that the emerging policy framework lacks clear rules, reflecting the peculiar character of German hegemony as well as deep divisions between core and periphery in the EU.

Unconventional central banking and the politics of liquidity

The 2008 financial crisis saw central banks introduce a variety of tools to shore up the financial system, including unconventional measures that made use of central bank balance sheets to directly shape markets. This paper argues that central banks increasingly rely on unconventional tools in noncrisis times to maintain confidence in an unstable financial system: in rich countries, outright asset purchase programs form the core of monetary policy, and in emerging capitalist economies, the sale and purchase of foreign exchange assets constitute the central mechanism of exchange rate policy. These interventions increasingly target ‘market dysfunction,’ as opposed to (a narrow interpretation of) monetary policy or the level of the exchange rate, suggesting a convergence in central bank operations around maintaining the plumbing of finance. Using two case studies – foreign exchange operations by the Reserve Bank of India and asset purchase programs by the U.S. Federal Reserve – the paper demonstrates a blurring of the boundaries between crisis and noncrisis interventions, and lends evidence to the concept of a de-risking state that guarantees liquidity. The paper concludes with a discussion of how a de-risking state exacerbates inequality, financial vulnerabilities and undermines meaningful action on pressing issues such as climate change.

Pre- and Post-Global Financial Crisis Policy Multipliers

This paper estimates the change in policy multipliers in the U.S. relative to their pre-2008 financial crisis levels. It also estimates the likely impact of the 2020 stimulus packages implemented to address COVID-19. The analysis is based on an augmented Blanchard-Perotti model that allows for the dynamic effects of shocks to the central bank balance sheet, real interest rates and debt levels on economic activity. The results suggest that expenditure multipliers have fallen post-2008, mostly because of higher government debt, implying that the effectiveness of fiscal policy has declined. They also suggest that the impact of quantitative easing is beneficial, but requires sizable interventions to have noticeable effects on real GDP. Because of rising debt stocks, dealing with a crisis is becoming more and more costly despite the current low interest rate environment.

The German Federal Constitutional Court Ruling and the European Central Bank’s Strategy

ABSTRACT The ruling of the German Federal Constitutional Court and its call for conducting and communicating proportionality assessments regarding monetary policy have been the subject of some controversy. However, it can also be understood as a way to strengthen the de facto independence of the European Central Bank (ECB). This article shows how a regular proportionality check could be integrated in the ECB’s strategy, which is currently undergoing a systematic review. In particular, it proposes that quantitative benchmarks for policy rates and the central bank balance sheet should be included. Deviations from such benchmarks can have benefits in terms of the intended path for inflation while involving costs in terms of risks and side effects that need to be balanced. Practical applications to the euro area are provided.

MONETARY REGIMES, MONEY SUPPLY, AND THE USA BUSINESS CYCLE SINCE 1959: IMPLICATIONS FOR MONETARY POLICY TODAY

The monetary authority’s choice of operating procedure has significant implications for the role of monetary aggregates and interest rate policy on the business cycle. Using a dynamic general equilibrium model, we show that the type of endogenous monetary regime, together with the interaction between money supply and demand, does well to capture the actual behavior of a monetary economy—the USA. The results suggest that the evolution toward a stricter interest rate-targeting regime renders central bank balance sheet expansions ineffective. In the context of the 2007–2009 Great Recession, a more flexible interest rate-targeting regime would have led to a significant monetary expansion and more rapid economic recovery in the USA.

ANALYSIS OF THE DEMAND FOR MONEY AND THE VELOCITY OF MONEY IN THE DIGITAL ECONOMY ERA: A CASE STUDY IN INDONESIA

In the digital economy era, efficiency and effectiveness are required in carrying out all life activities, including transaction activities. The urge to payment innovates systems as an effort to meet the needs of the community has led to several new non-cash-based payment instruments, such as paperless-based payment transactions. The existence of non-cash transactions shifts the role of cash in society. This study aims to examine the effect of paperless-based non-cash payments represented by credit cards, debit cards, and electronic money on the demand and velocity of money in Indonesia. Using monthly data sourced from Bank Indonesia and the Central Statistics Agency for the period 2010M1-2019M11. The right analysis used to see the effect of payment system innovation on-demand and velocity of money circulation is the Error Correction Model. The findings in the literature state that there is a significant effect of paperless-based payments as a form of payment system innovation on the demand and velocity of money circulation in Indonesia. The strong influence between the demand for money and the velocity of money with paperless-based non-cash transactions in Indonesia in the long term indicates that policymakers need to be careful in making decisions. The long-term relationship explains that the central bank can influence people's transaction behavior. Given that currency in circulation forms a significant part of a central bank's balance sheet, the shrinking demand for currency will have important implications on the central bank's seigniorage income, its independence, and its ability to conduct monetary policy. Thus, it is important to check and understand the trend of money demand and the velocity of money so that it can provide long-term profits.

Central Bank Digital Currency and Balance Sheet Policy

This paper studies how the introduction of a central bank digital currency (CBDC) interacts with ongoing monetary policies. We distinguish two kind of policies: standard policy, where the central bank invests in treasuries, and quantitative easing, where the central bank invests in risky securities. In each scenario, we introduce an interest-bearing CBDC, and study the equilibrium allocations. Our analysis reaches three main conclusions. The first is that the equilibrium impact of a CBDC depends on the ongoing monetary policy. Second, when the central bank conducts quantitative easing, the introduction of a CBDC is neutral under two conditions: the cost of issuing a CBDC is equal to the interest on reserves, and the demand for CBDC deposits is smaller than the amount of excess reserves in the system. Third, the introduction of a CBDC might render quantitative easing a quasi-permanent policy, as commercial banks optimally use their excess reserves to accommodate retailers’ demand for switching from bank deposits to CBDC deposits.

Stock market implications of Fed's balance sheet size

PurposeConsidering the relationship between the central bank balance sheet and unconventional monetary policy after the 2008 financial crisis, it is crucial to see how the unconventional monetary policy, given near-zero interest rates, affects future stock market performance. This paper analyzes the impact of the Fed's balance sheet size on stock market performance.Design/methodology/approachTo analyze the Fed's balance sheet size's long-term stock market implications, this paper uses the asset pricing framework of market return predictability such as Ordinary least squares (OLS) and Generalized method of moments (GMM) analysis.FindingsFindings in this paper suggest that the Fed's balance sheet size, deflated by asset market wealth, presents evidence of return predictability during 1926–2015 that is robust against standard controls. These results can be explained through the redistribution of risk and the wealth channels of monetary policy transmission. The changing balance sheet size of a central bank (1) affects systemic risk, yields and expectations and (2) signals the future direction of monetary policy and thus economic outlook.Research limitations/implicationsThe main implication of these findings is that policymakers should avoid a severe imbalance between a central bank's balance sheet size and assets market wealth.Originality/valueThe empirical evidence in this paper documents a century-old relation between the Fed's balance sheet size and US stock market return using the Fed's balance sheet data for the last 100 years and stock market returns from the Center for research in security prices (CRSP) database.

Covered interest parity deviations: Macrofinancial determinants

This paper studies how several macrofinancial factors are associated over time with the evolution of covered interest parity (CIP) deviations in the decade after the Global Financial Crisis. Changes in a number of risk- and policy-related factors have a significant association with the evolution of CIP deviations. Key measures of FX market liquidity and intermediaries' risk-taking capacity are strongly correlated with the cross-currency basis (the deviation from CIP), and the close relationship between broad U.S. dollar strength and the basis is driven mainly by a common factor depending on other safe-haven currencies' comovements. Post-crisis monetary policies also play a role, as demonstrated by the relationship between CIP deviations, central bank balance sheets, and term premia. Risk-related factors have more explanatory power than monetary policy-related factors over the entire 2010–2018 period, but they are approximately equally influential over the period's second half. Further highlighting the role of bank regulation, we offer evidence that the year-end dynamics of the three-month dollar basis depend on financial regulations targeting global systemically important financial institutions.

Central Bank Capital and Credibility: A Literature Survey

Research on central bank capital and credibility evolved from being an interest of developing countries to that of developed countries, following the 2008 global financial crisis. There is growing concern about central bank balance sheets at exit from quantitative easing. This paper surveys the literature in this context. It starts by citing early literature, which suggests that a central bank with insufficient capital may be pressured to pursue an inflationary policy at a time of crisis, thereby jeopardizing its credibility. A theoretical analysis of this problem is carried out using central bank budget constraints, and its intertemporal variant, leading to consideration of the solvency of the central bank. Several central banks make fiscal transfers to the government, and their solvency situation is influenced by whether they have fiscal transfers to and from the government or not.

The impact of size, composition and duration of the central bank balance sheet on inflation expectations and market prices

We analyse the effects of announcements of changes in the Eurosystem’s balance sheet size, duration and composition on inflation expectations, the exchange rate, the 10-year euro area government bond yield and stock returns, using local projections. We explicitly take into account interaction effects between the three balance sheet dimensions. We provide evidence for the duration extraction channel of monetary policy transmission as we find that the bond yield is sensitive to the combined impact of shocks to balance sheet size and duration. The exchange rate is also affected by a joint size-duration shock. Moreover, the bond yield and exchange rate are sensitive to the joint effect of changes in size and composition. The results indicate that interactions between balance sheet dimensions matter.

The Impact of Size, Composition and Duration of the Central Bank Balance Sheet on Inflation Expectations and Market Prices

We analyse the effects of announcements of changes in the Eurosystem’s balance sheet size, duration and composition on inflation expectations, the exchange rate and the 10-year euro area government bond yield, using local projections. We explicitly take into account interaction effects between the three balance sheet dimensions. We provide evidence for the duration extraction channel of monetary policy transmission, as we find that the bond yield is sensitive to the combined impact of shocks to balance sheet size and duration. The exchange rate is also affected by a joint size-duration shock. Moreover, the bond yield and exchange rate are sensitive to the joint effect of changes in size and composition. The results indicate that interactions between balance sheet dimensions matter.

The Implications of Liquidity Regulation for Monetary Policy Implementation and the Central Bank Balance Sheet Size: An Empirical Analysis of the Euro Area

We analyse the impact of the Liquidity Coverage Ratio (LCR) on the demand for central bank reserves in the euro area with difference-in-differences estimation techniques. Using a novel dataset and an identification strategy that exploits the cross-country heterogeneity in the regulatory treatment of reserves for LCR purposes prior to the announcement of a harmonised euro area standard as a quasi-natural experiment, we find evidence that points to LCR-induced demand for reserves. Specifically, our results suggest that banks with low LCRs relative to peers increased their central bank reserve holdings as a result of the LCR regulation. Our findings have economically meaningful implications for the operational framework of monetary policy and imply that the Eurosystem’s balance sheet may need to remain larger than it was prior to the financial crisis and the associated introduction of new liquidity regulation.