This article provides the first detailed institutional analysis of the UK government’s expenditure, revenue collection, and debt issuance processes. We show that public expenditure is always financed through money creation rather than taxation or debt issuance. Spending involves the government drawing on a sovereign line of credit from a core legal and accounting structure known as the Consolidated Fund (CF). The Bank of England then debits the CF’s account at the Bank and credits other government accounts held at the Bank. This creates new public deposits, which are used to settle spending by government departments via the commercial banking sector. Only the UK parliament can mandate expenditures from the CF. Revenue collection, including taxation, involves the reverse process, crediting the CF’s account at the Bank, offsetting past injections. Similarly, gilts have been issued to temporarily withdraw money to assist monetary policy objectives. Under the current conditions of excess reserve liquidity, however, debt issuance is best understood as a way of providing safe assets and secure collateral to the non-bank private sector. The findings support neo-Chartalist accounts of the workings of sovereign currency-issuing nations and provide additional institutional detail regarding the apex of the monetary hierarchy in the UK.

Abstract Monetary policy tightening in the Euro Area has driven record-high bank profitability, increasing public pressure and prompting legislative proposals for bank profit levies in several Euro Area countries during 2022 and 2023. While much focus has been directed to the effects of bank levies introduced in the aftermath of the Global Financial Crisis, the motivation behind the introduction of the recent wave of extraordinary bank taxes has not been studied. This paper seeks to identify the most important characteristics of the banking, macroeconomic and governmental sectors which lead to the introduction of such taxes. Our findings show that higher banking profitability increases the likelihood of a bank tax, while greater excess reserves at the central bank reduce it, suggesting that rising profitability was not driven by remuneration on these reserves. Regarding macroeconomic conditions, higher inflation lowers the probability of implementing an extraordinary bank tax, implying that countries adopting such measures were not disproportionately impacted by the Euro Area’s inflation surge. In terms of government characteristics, we find no evidence that higher deficits or government debt made countries more likely to introduce a bank tax, suggesting revenue generation was not the primary motive. However, lower government effectiveness is linked to a higher probability of implementation.

In its response to the economic and financial crises of 2008, the sovereign debt and euro crisis of 2010–2015, and the COVID-19 pandemic of 2020–2023, the European Central Bank (ECB) implemented an unconventional monetary policy aimed at providing liquidity for more than a decade, through a complex set of tools and operations that make up the so-called quantitative easing. The results of all of them are being analyzed from different perspectives. This paper studies the relationship between a large base money, characterized by a voluminous concentration of liquidity in the form of excess reserves, and broad money (the broad M3 aggregate). Our econometric work shows a low elasticity of broad money with respect to base money, concluding the existence of a weak relationship between both monetary magnitudes, with a sharp decline in the money multiplier. The demand for money has remained stable relative to its determining variables, interest rates and income. At the same time, some practices related to the handling of excess liquidity by European banks through deposit facilities deserve consideration. We propose strict control by the monetary authority over the nature and origin of the funds that constitute the excess liquidity derived from the ECB’s unconventional operations, and over its management.

The Central Bank of Suriname (CBvS) undertook significant steps to modernize its monetary policy framework by shifting from an exchange rate regime to a monetary targeting regime in 2021. The main objective was to stabilize inflation and manage liquidity effectively, especially after the Suriname dollar's sharp depreciation and high inflation. The CBvS faced challenges in managing excess reserves, leading to the introduction of tools like Central Bank Certificates (CBCs) in 2022 and the increase in reserve requirements in 2023. However, persistent issues like low engagement in auctions and high bid rates continued to complicate liquidity management. The mission supported the CBvS by introducing an advanced statistical framework for liquidity forecasting and by assessing challenges in the money market participation. The forecasting framework integrates 12 forecasting models, helping to enhance the accuracy of reserve money projections and improve operational efficiency. The mission also involved collaborative efforts through surveys and workshops with commercial banks to address their concerns and ensure better understanding and participation in the monetary policy framework. The recommendations include reviewing the use of CBCs, improving liquidity forecasting, and modernizing the banking infrastructure to better align with the CBvS' policy objectives and enhance the effectiveness of the monetary system.

This paper primarily examines the impact the COVID pandemic on Chinas GDP and the effectiveness of The Peoples Bank of Chinas monetary policy in stimulating Chinese economy from the COVID depression. PBOC has attempted to increase consumption and investment through expansionary monetary policy. However, decreasing GDP growth rate and abnormally low inflation rate show that PBOCs monetary policy has not been very effective. Calculations in velocity of money and data of increasing excessive reserves, and high gross savings rate shows that this phenomenon might relate to insufficient consumption and overproduction that already exists in Chinese economy. To keep the economy on a growth trajectory, it is likely for Chinese government to address the current issues through involving measures such as establishing a better welfare system, changing the tax structure, and reducing income inequality among residents so that Chinese economy would be transformed from an investment-oriented economy to a more consumption-oriented economy.

Payment systems innovations, substitutive effects, and the real economy: The intervening role of currency holdings and excess reserves

Given that the Central Bank of Bosnia and Herzegovina does not have the legal authority to lend to residents, the country's monetary regime is deprived of a reference interest rate. Therefore, we approximated the monetary policy cycle in Bosnia and Herzegovina by using the ratio between the monetary aggregate M2 and gross domestic product. In this paper, we demonstrated the high persistence of the monetary cycle, confirmed its dependence on base money, and included in our analysis the interest rate differential between foreign and domestic rates, as well as the financial cycle. A significant portion of monetary conditions is shaped by domestic banks, which create secondary deposits through deposit-credit multiplication, thereby confirming the endogenous theory of money. As expected, the monetary cycle is also influenced by the interest rate differential, with this relationship being inverse. In order to increase the liquidity of the economy, that is, the value of the monetary cycle, we recommend implementing a policy of monetary regulation. This would include limiting the exposure of BH banks to foreign markets, while simultaneously introducing a negative fee on excess reserves held by banks at the Central Bank of Bosnia and Herzegovina.

The article examines the main trends in the changing structure of official reserve assets. For more than half a century the US dollar has been the dominant reserve currency in most countries. The dollar’s reserve currency status has been based on its global use for trade invoicing, cross-border investment and exchange rate anchoring. The dollar’s dominance was also supported by the US status as a global power, one that helps to guarantee the security of its allies. But, since the beginning of this century, two important trends can be noted: a significant increase in the total volume of global reserve assets and a decrease in the dollar’s share in them. Мany central banks, especially holders of excessive reserve assets, have taken the path of diversifying their foreign exchange reserves, increasing the share of nontraditional reserve currencies and gold, and reducing dependence on the dollar. The dominant role of the dollar is also under pressure from the policies pursued by issuers of competing currencies in order to strengthen their international role, primarily by the EU and China. A potential threat to the dollar’s dominance may be the development by many countries of the central bank digital currencies, which are expected to be used in cross-border transactions. The trend of de-dollarization of reserve assets is promoted by the US itself, which actively uses the policy of sanctions to achieve its foreign policy goals, which undermines confidence in the dollar. Rising geopolitical tensions could trigger strategic adjustments in the structure of foreign exchange reserves.

Abstract When the Federal Reserve first paid interest on excess reserves (IOER) in October 2008, banks faced a choice to earn a “better than” risk‐free rate, or lend to earn a higher, riskier rate. Evidence suggests the “reserves‐lending puzzle” is not driven by endogeneity from reverse causality, flight to safety, or increased Treasury supply, but by the introduction of the “reserve premium” (IOER‐3MT), which is associated with a reduction of domestic bank‐level lending by ‐5.1% (‐$420.2B). Findings suggest the reserves risk channel can aid in restricting inflation. Additionally, recent Senior Financial Officer Surveys corroborate the conclusions presented in this paper.

Quantitative Easing (QE) created huge excess reserves of Eurozone credit institutions. When Quantitative Tightening (QT) set in, these reserves had to be remunerated by the European Central Bank (ECB) at the deposit facility rate. Hence, credit institutions presently benefit from large interest incomes on their reserve holdings, reflected by increasing share prices. I study the case of Deutsche Bank Aktiengesellschaft (AG) using a structural vector autoregression (SVAR) framework to identify the root causes of the recent rise in Deutsche Bank share prices. In order to identify the effects of QT on stock prices, each empirical model is estimated on two different samples: One sample which ends in June 2022 when QE was discontinued and a second sample spanning the same time period plus the rather short QT-period July 2022 to September 2023. The stark difference in results suggests that autonomous monetary policy decisions which raised the deposit facility rate since June 2022 have significantly increased the price of Deutsche Bank stocks. Since the interest payments to commercial credit institutions are not offset by revenues from ECB assets purchased during QE, this implies that private wealth of shareholders increased at the expense of central bank profits that would normally contribute to public budgets.

ABSTRACT The effect of macroeconomic indicators on tourism demand is well-established. However, the plausible impact of interest rate on excess reserves (IOER), an unconventional monetary policy, on inbound tourist flow is unclear. Using monthly data from 2011:M1 to 2019:M9, I assess the responsiveness of inbound tourist flow from the United Kingdom, Germany, Brazil, France, India, and Italy, six major originators of foreign tourists to the United States, to changes in the IOER of the United States. The results of an autoregressive distributed lag model and generalized methods of moment show that monetary expansion in response to a drop in the IOER by the Federal Reserve through the exchange rate channel boosts inbound tourist flow to the United States.

The financial cycle is determined based on real loans or the ratio of loans to nominal GDP. In the research, we applied the standard methodology of determining trends and cycles as deviations from the trend using the Hodrick-Prescott filter. We entered the research with two hypotheses. We assumed that the BH financial cycle is different from the financial cycle in the eurozone. We also assumed that the difference between the highest and the lowest point of the financial cycle is the most pronounced in Bosnia and Herzegovina. In addition to the financial cycle in Bosnia and Herzegovina, the subject of analysis was the financial cycle in eurozone, Slovenia, Serbia, Bulgaria, and Croatia. Measured by real loans, Bosnia and Herzegovina had two financial cycles in the past period, while the ratio of loans to GDP indicates only one financial cycle. Both methods of determining the financial cycle show that credit activity in BH in the recent period is significantly below the trend. Compared to other countries, the correlation between the BH financial cycle and that of the eurozone is relatively low. Due to the characteristics of the banking and financial market, the absence of the credit function of the central bank on the domestic market, and the generally low degree of monetary policy discretion, the recent values of the financial cycle in BH are the lowest in the selected sample of currency areas. In BH the biggest difference is shown in the final values of the financial cycle measured by real credit, and the same result is shown in the financial cycle based on financial intermediation depth. The exception is Slovenia, where the banking crisis had a long-term impact on the financial cycle. At the end of the analyzed period, BH has the lowest value of the financial cycle. For the correction of the financial cycle, BH has at its disposal the existing instruments of monetary policy, the reserve requirements, remuneration on reserve requirements, and excess reserves, and it can introduce new ones; ex nihilo issuance of primary money and macroprudential regulation. The currency board regime does not guarantee compliance of the financial cycle with the reserve currency currency area. Bosnia and Herzegovina has a financial cycle, which is significantly different from that of a country with a reserve currency. A significant deviation from the trend value of the loan-to-GDP ratio is also connected with the use of credit potential for exposure of BH banks to predominantly еurozone markets. The extremely low recent value of the BH financial cycle indicates the low level of liquidity of the BH economy. The potential ex nihilo issue of the primary money of the central bank in the BH monetary regime would be a strong corrective factor of the financial cycle in Bosnia and Herzegovina.

Abstract Following the collapse of Lehman Brothers in September 2008, the Federal Reserve underwent a significant shift in how it implemented monetary policy, transitioning to an excessive‐reserves framework that it had deemed too radical and rejected just months prior. This shift involved borrowing excessive reserves from banks, deviating from its traditional method of borrowing only the amount banks needed to meet reserve requirements and address clearing needs. Despite initial intentions to revert to the necessary‐reserves framework, subsequent developments, including three rounds of quantitative easing, led to the permanent adoption of the excessive‐reserves approach in January 2019 by the Federal Open Market Committee (FOMC). This decision was a mistake. The framework has not yielded the purported benefits, such as simpler policy implementation, and has required the Fed to be vastly larger than originally anticipated. Advocates of the excessive‐reserves approach argue it aligns with the Friedman rule, but alternatives like a voluntary‐reserve‐requirement regime could achieve similar outcomes without the drawbacks.

A dynamic yard space reservation algorithm based on reward-penalty mechanism

Abstract This paper examines the potential impact a central bank digital currency (CBDC) on banks’ balance sheets. We first analyze the possible implications of the introduction of a CBDC for the banking system and the economy as a whole. Our analysis indicates that the impact of a CBDC depends on a number of design choices and on how credit institutions re-optimize their balance sheets in response to the outflow of deposits caused by the substitution of private money with public digital money. We then present a series of illustrative simulations on the impact of a CBDC on the funding structure and profitability of credit institutions using data on Italian banks between June 2021 and March 2023. The analysis suggests that the overall impact on banks’ funding could be manageable in the presence of individual holding limits and in an environment characterized by ample liquidity and stable funding for credit institutions. The cost of covering the reduction of deposits would be relatively higher for intermediaries with low excess reserves and for those that may need to issue long-term liabilities to maintain stable funding levels above regulatory requirements.

We study the evolving operating procedures used by the ECB since its creation. During the period up to 2015, bank reserves were scarce and the ECB, like other central banks, used a corridor system in which the money market rate could fluctuate within the bounds set by the lending and the deposit rates. With the start of Quantitative Easing (QE) the operating procedure evolved into a regime of reserve abundance. This regime has become problematic since the inflation surge forced the central banks to raise the policy rate. The result has been a massive transfer of central banks’ profits (and more) to the banks. We propose a two-tier system of reserve requirements that would only remunerate the reserves in excess of the minimum required. This would drastically reduce the giveaways to banks, allow the central banks to maintain their current operating procedures and make monetary policies more effective in fighting inflation.This paper was presented at the ECB@25 Symposium at Erasmus University, Rotterdam on 16th January 2024. We are grateful to Mary Pieterse-Bloem, Sylvester Eijffinger, Casper de Vries, Charles Goodhart and other participants in the Symposium for comments and suggestions. We also profited from comments and suggestions of an anonymous referee.Previous versions of this paper (De Grauwe and Ji, 2023a, 2023b) profited from comments by Ignazio Angeloni, Peter Bofinger, Robert Holzmann, Pablo Rovira Kaltwasser, Karel Lannoo, Vivien Lévy-Garboua, Anna Lozmann, David Marsh, Wim Moesen, Joachim Nagel, Theo Peeters, Stefan Schmitz, Miklos Vari, and by participants in seminars and presentations at the London School of Economics, King’s College (London), the Bundesbank, the Central Bank of Luxembourg, OMFIF, Sciences Po (Paris), the Austrian National Bank, SUERF, the Polish National Bank and the National Bank of Ukraine.

Monetary policy and reserve requirements with a zero-interest digital euro

The study scrutinizes the influence of the selective macroeconomic forces on the liquidity of Bangladesh. The ratio of excess reserve and total deposit liability is used to represent the liquidity of Bangladesh while total domestic credit, lending rate, consumer price index (CPI), excess reserve and exchange rate are selected as the macroeconomic forces. Using yearly data from 1986 to 2021, different time-series techniques have been used. Cointegration test explicates no cointegrating relationship among the variables. It has been found that 58% of the variation of liquidity is explained by the variation of liquidity itself 20% by domestic credit, 19% by consumer price index and another 12% by the other variables like excess reserve, exchange rate and lending rate. From the result of VAR lag order selection criteria, the maximum lag of the series is one. VAR model suggests the stability and no autocorrelation among the variables. From granger causality test, it can be inferred that domestic credit can forecast consumer price index, consumer price index can cause excess reserve of the country, consumer price index can forecast lending rate, domestic credit can cause increase or decrease the liquidity of the country, liquidity can granger cause excess reserve and excess reserve can cause any changes in liquidity. Lastly, excess reserve can predict lending rate. This results will help the policy makers to predict the liquidity trends and the impact of some selected macroeconomic variables contributing to predict the liquidity.

Abstract We examine the relation between excess corporate cash holdings and equity option market liquidity from January 3, 2005 to December 31, 2019. We show that the level of cash reserve in excess of what can be captured by firm characteristics significantly explains stock option liquidity. Trading volume and option open interest increase in companies with a higher magnitude of excess cash, whereas the bid–ask spreads of stock options decline in excess cash. Our findings confirm the theoretical prediction that excess cash improves option market liquidity as it reduces adverse selection problems caused by uncertainty in firm valuations. This relation remains more pronounced with put options, out‐of‐the‐money contracts, and short‐maturity contracts. In addition, excess cash has a stronger impact on option liquidity within firms that have a greater degree of informed trading and during high‐volatility periods in financial markets. Our results show that when uncertainty about firm prospects rises, excess cash becomes more valuable and affects option market liquidity.

The major central banks now operate in a regime of abundant bank reserves. As a result, they can only raise the money market rate by increasing the rate of remuneration of bank reserves. This, in turn, leads to large transfers of central banks’ profits to commercial banks that will become unsustainable and renders the transmission of monetary policies less effective. We propose a two-tier system of reserve requirements that would only remunerate the reserves in excess of the minimum required. This would drastically reduce the giveaways to banks, allow the central banks to maintain their current operating procedures and make monetary policies more effective in fighting inflation.