Description
TOPIC
Propose and defend a new monetary policy with emphasis on how you would implement it. Please follow this structure.
INTRODUCTION AND THESIS: The paper requires a thesis (argument) on the first page. The paper’s thesis will clearly state your monetary policy, how it differs from current policy, and the reasons you recommend this change. You do not need to mimic the structure of Fed pronouncements. If I do not know what the thesis of the paper is by the end of the first page, then I will stop reading and grade the paper accordingly.
SECTION 1:
This section covers where the economy is now and where it is going. This section needs to include charts of relevant economic indicators that you constructed in Excel using FRED data (St. Louis Federal Reserve Economic Data). Do not grab charts or tables from other sources. Only charts that you draw in Excel using FRED data can earn chart evidence points.
SECTION 2:
The section covers the Fed’s current policy, how it is being implemented, what it hopes to accomplish, and where your analysis sees this policy taking the economy.
In class, we discussed the current statements by the Fed. Also, the Fed has a list of each tool: Fed Policy Tools
SECTION 3:
This section covers your proposed change in policy, how you will implement it, and what you expect will result.
Throughout, you will want to use (and explicitly reference in text) our course readings. They should be used in text form: either quoted or paraphrased. Again, do not use outside sources, charts, tables, etc.
PARTICULARS
The paper’s text will be around 1,500 words (about six pages) not counting charts, but it can run longer if you have relevant arguments to make.
Papers will be submitted as a Microsoft Word document through TCU Online.
Papers will be double spaced with Times New Roman 12 point font.
Papers will use a student’s TCU ID number rather than their name.
Papers will use in-text citations to refer to relevant class readings.
Evidence points will focus on class readings. No outside sources will be used.
Endnotes or footnotes can be used if needed.
NO OUTSIDE SOURCES
Unformatted Attachment Preview
3/18/24, 8:03 PM
Monetary Policy Paper – Economics of Financial Markets 030 (Quinn) – Texas Christian University
Paper Rubric
Course: Economics of Financial Markets 030 (Quinn)
Criteria
Thesis: 30
points
Best
Better
Not So Better
Not Better
The introduction
contains a clear,
arguable sentence
(or group of
sentences) which
articulates a set of
related economic
points and
explains how they
cohere into a
causal narrative
that is relevant to
the assigned
topic. Also, it may
acknowledge the
implications of
alternative
arguments.
The introduction
contains a clear,
arguable sentence
(or group of
sentences) which
articulates a set
related economic
points relevant to
the assigned
topic.
The introduction
contains a clear,
arguable sentence
(or group of
sentences) which
articulates an
economic point
relevant to the
assigned topic.
Presents central
idea in general
terms, often
depending on
platitudes or
cliches.
The introduction
does not contain a
clear, arguable
sentence (or
group of
sentences) which
articulates a
central economic
point.
https://tcu.brightspace.com/d2l/lms/dropbox/user/folder_submit_files.d2l?db=305721&grpid=0&isprv=0&bp=0&ou=272041
1/5
3/18/24, 8:03 PM
Criteria
Economics: 40
points
Monetary Policy Paper – Economics of Financial Markets 030 (Quinn) – Texas Christian University
Best
Better
Not So Better
Not Better
Frequently and
correctly explains
economic reasons
for outcomes in
ways that
Often correctly
explains economic
reasons for
outcomes relevant
to the topic, i.e.
Occasionally
gives, but does
not explain or
incorrectly
applies, economic
Mostly does not
give economic
reasons for
outcomes.
Instead, it might
effectively
advance the
paper’s thesis and
are relevant to the
many economic
whys explained. If
the assignment
requires a
reasons for
relevant
outcomes. Shows
lapses in
depend on
unsupported
opinion or
personal
assigned topic.
Also, it may
explain the logical
implications of
theoretical
schematic, then it
is correctly used.
understanding. If
the assignment
requires a
theoretical
experience, or
assumes that
evidence speaks
for itself and
schematic, then it
is incorrectly
used.
needs no
application to the
point being
discussed. If the
assignment
requires a
theoretical
schematic, then it
is absent.
Lacks references
to class readings.
Lacks self-created
Excel charts.
contradictions,
qualifications, or
limits of the
thesis. If the
assignment
requires a
theoretical
schematic, then it
is correctly and
effectively used.
Evidence: 30
points
Referenced class
readings and selfcreated Excel
charts are
Referenced class
readings and selfcreated Excel
charts are
Referenced class
readings and selfcreated Excel
charts are few or
numerous and
correctly applied
to outcomes and
economic
arguments in ways
that effectively
advance the
paper’s thesis and
are relevant to the
assigned topic.
numerous and
correctly applied
to outcomes or
economic
arguments that
relevant to the
assigned topic.
misunderstood
when applied or
are not relevant to
the assigned
topic.
https://tcu.brightspace.com/d2l/lms/dropbox/user/folder_submit_files.d2l?db=305721&grpid=0&isprv=0&bp=0&ou=272041
2/5
3/18/24, 8:03 PM
Monetary Policy Paper – Economics of Financial Markets 030 (Quinn) – Texas Christian University
Overall Score
Best
Better
Not So Better
https://tcu.brightspace.com/d2l/lms/dropbox/user/folder_submit_files.d2l?db=305721&grpid=0&isprv=0&bp=0&ou=272041
Not Better
3/5
3/18/24, 8:03 PM
Monetary Policy Paper – Economics of Financial Markets 030 (Quinn) – Texas Christian University
https://tcu.brightspace.com/d2l/lms/dropbox/user/folder_submit_files.d2l?db=305721&grpid=0&isprv=0&bp=0&ou=272041
4/5
3/18/24, 8:03 PM
Monetary Policy Paper – Economics of Financial Markets 030 (Quinn) – Texas Christian University
https://tcu.brightspace.com/d2l/lms/dropbox/user/folder_submit_files.d2l?db=305721&grpid=0&isprv=0&bp=0&ou=272041
5/5
Liberty Street Economics
FEBRUARY 01, 2016
Standard Elements of a Monetary Policy Implementation
Framework
Emily Eisner, Antoine Martin, and Ylva Søvik
In the minutes of the July 2015 Federal Open Market Committee (FOMC) meeting, the chair
indicated that Federal Reserve staff would undertake an extended effort to evaluate potential longrun monetary policy implementation frameworks. But what is a central bank’s monetary policy
implementation framework? In a series of four posts, we provide an overview of the key elements
that typically constitute such a framework.
The main source for this post is a paper from the Bank for International Settlements (BIS)
on Monetary Policy Frameworks and Central Bank Market Operations, which gives an overview of
Basel Committee-member central banks’ frameworks. We are interested in these global frameworks
because they offer a broad view of what constitutes the standard elements necessary for monetary
policy implementation. However, we do not attempt to draw specific implications from the choices of
individual central banks. (Our discussion relies on a basic understanding of central bank activity. For
a good primer on monetary policy implementation in the Federal Reserve System, please
see “Monetary Policy 101: A Primer on the Fed’s Changing Approach to Policy Implementation”
[Ihrig, Meade, and Weinbach 2015].)
It is important to distinguish between monetary policy formulation, which specifies what the stance
of monetary policy should be, and monetary policy implementation. For example, in the United
States, the FOMC sets the stance of monetary policy by choosing the appropriate level of the federal
funds rate. Our interest is in the tools that are available to make sure that the fed funds rate will
indeed be close to the level chosen by the FOMC.
In this first post, we focus on the more standard elements of a monetary policy implementation
framework, the central bank’s target rate, and the tools that central banks have to achieve their
targets (specifically the central bank facilities and operations), as well as policies that influence the
supply and the demand for reserves.
In the next three posts, we will discuss elements of an implementation framework that have not been
studied as much. In some cases, these elements changed a lot during the crisis. Our post tomorrow
will consider the type of counterparties that can borrow from or lend to a central bank and the
collateral against which these counterparties can receive a loan from a central bank. The other two
posts, which will run Wednesday and Thursday, will discuss the composition and structure of central
banks’ balance sheets before and after the crisis.
What are the target rates?
Many central banks specify a market interest rate that they target. A large majority of central banks
target an overnight market rate, but these rates can come in many flavors. Some central banks, such
as the Bank of Canada, target an interest rate on secured loans, meaning that the loans considered
are backed by collateral. Others, such as the Federal Reserve, target an unsecured rate. Some central
banks specify that they use a rate on interbank loans, while others are not specific about which
financial institutions are counterparties in the market that determines their target.
While targeting an overnight rate is very common, it is far from the only choice. Before the crisis, the
Swiss National Bank targeted a three-month interest rate—the three-month Libor. In Norway, the
central bank targets a “short” rate without being explicit about the specific term. A benefit of longerterm rates is that they can affect the real economy more directly, as argued in this article in
our Current Issues series. That said, longer-term rates are more difficult for the central bank to
control.
Other central banks, like the European Central Bank (ECB), do not specify an interest rate target. As
of 2009, the Reserve Bank of India had no formal rate target and had as a goal of its operations to
reduce market volatility. The central bank in Hong Kong, a small open economy, uses the spot
exchange rate as its target rate. With its policy of quantitative and qualitative monetary easing, the
Bank of Japan targets the monetary base.
These differences reflect variations among central bank mandates and objectives, as well as the level
of development of the financial markets in which the central banks operate.
How do central banks work to achieve their targets?
Central banks implement their interest rate targets by influencing the cost of borrowing reserves
held at the central bank. There are two basic approaches. One way is to make reserves sufficiently
scarce. Basic supply and demand logic implies that the cost of borrowing reserves increases with
scarcity. The other way is to rely on arbitrage. If a central bank pays an interest rate on its reserves,
banks should be unwilling to lend these holdings at a rate that is lower than what they could earn
from the central bank.
• Implementation Relying on Scarcity
Most central banks rely on scarcity to implement their interest rate target. This group often uses
reserve requirements to influence the demand for reserves. Reserve requirements usually force
banks to hold as reserves an amount that corresponds to a given fraction of their demand deposits.
Among the central banks that have reserve requirements, many require that banks hold a relatively
small amount in reserves, usually less than 10 percent of a bank’s demand deposits, but some central
banks have much higher requirements, like the Central Bank of Brazil, which requires 45 percent of
deposits.
Central banks that set reserve requirements usually specify a reserve maintenance period, a span of
time over which a specific amount of reserves is required. In the BIS survey, the length of the
maintenance periods varied from two weeks to a month. All central banks with reserve requirements
allow reserve averaging during the maintenance period, meaning that the requirement does not need
to be met every single day, but on average over the maintenance period. Reserve averaging reduces
interest rate volatility by flattening the demand curve for reserves, as shown in this paper.
If the central bank knows the demand for reserves, it can set the supply of reserves to intersect the
demand at the desired interest rate, as explained in this Liberty Street Economics post on “Corridors
and Floors in Monetary Policy.” Market operations are typically used to adjust the supply of reserves.
All of the central banks described in the BIS document use some form of market operations, usually
short-term repurchase agreements, as their main form of market operation.
Until the financial crisis, the Bank of England had a system where banks could choose voluntary
targets for the reserves they hold over the maintenance period. That meant that banks would not face
any opportunity cost as long as they held reserves within a given range around their target.
Central banks also use specific facilities, usually to dampen fluctuations in market interest rates. All
central banks in the survey have lending facilities which lend to banks upon request. In addition,
many central banks have deposit facilities, where banks can deposit excess reserves and earn an
interest rate. The interest rates at the lending facility should provide a ceiling on interbank rates of
the same maturities and the deposit facility should provide a floor, as explained in the “Corridors and
Floors” post cited above, so the target interest rate can be contained within some bounds.
In systems that rely on scarcity, holding too few reserves has a cost because there are penalties for
not meeting the requirement; conversely, holding excess reserves has an opportunity cost since they
earn a low return. Hence, banks have an incentive to hold exactly the amount of reserves they need,
but not more. This structure promotes trading in money markets as banks try to manage their
reserves.
• Implementation Relying on Arbitrage
Before the crisis, a small number of central banks relied on arbitrage to implement monetary policy,
among them the Reserve Bank of New Zealand and Norges Bank. These central banks supplied a
relatively large quantity of reserves, even before the crisis, so they could not rely on scarcity. Instead,
these central banks set the interest rate on their deposit facility at, or very close to, their policy rate.
This rate acted as a “floor” for their target rate. Since the financial crisis, other central banks have
increased reserves substantially through asset purchase programs (for example, the Bank of
England, the Bank of Japan, the ECB, the Federal Reserve, and the Riksbank), such that these
central banks now rely on arbitrage to steer their target rates.
Central banks relying on arbitrage don’t need to manage the level of reserves very closely and may
not need to conduct market operations. Indeed, under these frameworks, even large fluctuations in
the level of reserves should not affect money market rates very much and banks are roughly
indifferent about the amount of reserves they hold. Holding large reserves can also reduce incentives
for banks to trade in interbank markets, with a number of countries that increased the supply of
reserves during the crisis experiencing a decrease in interbank market activity.
There is a wide variety in the tools used by central banks to conduct monetary policy. In our next
three posts, we will explore other dimensions in which these differences manifest themselves.
FEBRUARY 02, 2016
Counterparties and Collateral Requirements for
Implementing Monetary Policy
Emily Eisner, Antoine Martin, and Ylva Søvik
What types of counterparties can borrow from or lend to a central bank, and what kind of collateral
must they possess in order to receive a loan? These are two key aspects of a central bank’s monetary
policy implementation framework. Since at least the nineteenth century, it has been understood that
an important role of central banks is to lend to solvent but illiquid institutions, particularly during a
crisis, as this provides liquidity insurance to the financial system. They also provide liquidity to
markets during normal times as a means to implement monetary policy. Central banks that rely on
scarcity of reserves need to adjust the supply of liquidity in the market, as described in our previous
post. In this post, we focus on liquidity provision related to the conduct of monetary policy.
Although there are some exceptions, central banks normally provide liquidity against collateral and
to a restricted set of counterparties. The objective of these restrictions is to limit the central bank’s
exposure to credit risk. Any losses are ultimately borne by taxpayers, so it is important to avoid them.
Indeed, most central banks make profits that are rebated to the government. Lower profits, or an
outright loss, would have to be made up by additional tax revenue or expenditure reductions. Large
or regular losses could also weaken a central bank’s reputation and threaten its independence. For a
more detailed discussion of central bank collateral and counterparty policies, see the IMF working
paper, “Central Bank Collateral Frameworks: Principles and Policies.” For a detailed description of a
current collateral and counterparty framework, see the Bank of England’s Red Book.
Understanding Counterparties
A narrow set of counterparties will typically prove easier for a central bank to monitor. In normal
times, its counterparties will redistribute liquidity efficiently through financial markets. However,
during periods of market turbulence financial institutions may become reluctant to lend to each
other so relying on a narrow set of counterparties may not work effectively. This could reduce the
ability of the central bank to provide funding when and where it is needed.
Although a wider set of counterparties can increase a central bank’s monitoring costs, such expenses
can be reduced by requiring collateral, particularly if the required collateral is very safe.
Nevertheless, it is important for a central bank to be able to assess the solvency and viability of its
counterparties. This is one reason central banks often have supervisory authority over the
institutions to which they can lend.
Most central banks have largely the same counterparties in their market operations and standing
facilities. This is the case, for instance, for the European Central Bank (ECB), the Bank of England
(BoE), Norges Bank, and the Reserve Bank of Australia (RBA). However, the RBA uses a more
expansive definition of eligible institutions for its market operations than for its standing facilities.
The Federal Reserve has different counterparties for its short-term market operations, which are
directed at adjusting the supply of reserves, than for its standing facilities, which can help prevent
market rates from increasing too much. The supply of reserves is typically adjusted through
repurchase agreements, or repos, with primary dealers that are not necessarily deposit-taking banks,
and most deposit-taking U.S. banks do not participate in these operations. Conversely, only deposittaking U.S. banks have access to liquidity insurance through the discount window.
When the counterparties for a central bank’s standing facilities and market operations coincide,
deposit-taking banks are always eligible counterparties. In some cases, such as at the BoE until
2009, only a subset of banks is eligible. Some central banks also require that their counterparties be
of a sufficiently large size. Even when these limitations are not binding, many smaller banks choose
to forgo the costs associated with becoming a direct counterparty. Typically only domestic banks are
eligible, but a number of central banks allow local branches of foreign banks be counterparties. Some
central banks accept bank-like savings institutions as counterparties. For instance, building societies
can be counterparties with the BoE. It should be noted that the definition of a bank varies between
jurisdictions. In some jurisdictions, the term “bank” includes universal banks, which can have both a
deposit-taking institution and a broker-dealer. In other jurisdictions, bank only refers to deposittaking institutions.
Some counterparties can lend to the central bank but cannot borrow. For example, the Fed borrows
from money market mutual funds (MMFs) through its reverse repo (RRP) program, but MMFs
cannot borrow from the Fed. In addition, some central banks give or have the discretion to give nonbanks access to facilities or market operations for financial stability purposes, but we will not discuss
that further here.
Collateral for Open Market Operations
When setting their collateral policies, central banks need to balance the need for adequate protection
against possible losses with the need for the collateral to be sufficiently plentiful. If the acceptable
collateral is too scarce, the central bank may not be able to conduct the open market operations
necessary to implement monetary policy effectively and to support the smooth functioning of the
payment system.
Some central banks, including the Fed, only accept a narrow set of very safe collateral for their
monetary policy operations, such as domestic government debt and debt issued by domestic
government-guaranteed agencies. These assets are risk free from the point of view of the
consolidated sovereign and are accepted by all central banks. Accepting only this restricted set works
well if the supply of outstanding government bonds in local currency is large, or if the liquidity needs
of the financial system are small. Historically that has been the scenario faced by the Fed, although
there were some concerns that the supply of government debt might become too small around the
turn of the century, as discussed in this paper from the Federal Reserve Bank of Kansas City. The
BoE also accepted only a narrow range of collateral before the crisis, although it accepted some
highly rated non-domestic government debt.
In some cases, allowing only domestic government debt and debt issued by domestic governmentguaranteed agencies as collateral will not be sufficient for a central bank to carry out the necessary
monetary operations. For example, some countries have too little outstanding sovereign debt. This is
the case for the Reserve Bank of Australia and theReserve Bank of New Zealand. Furthermore, some
interbank payment systems require a lot of central bank lending in order to function smoothly. This
is the case for Norges Bank. In each of these cases, it may be necessary to expand the set of
acceptable collateral at the central bank. Finally, the ECB, and thus the Eurosystem—which
comprises national central banks in the euro area and the ECB—accepts a broad range of assets as
collateral. The aim is to enable a broad and heterogeneous set of banks to borrow from the central
bank and to avoid a preferential treatment of government debt.
When central banks accept a wider set of collateral, they face a trade-off between different sources of
risk. Enlarging the set of acceptable collateral beyond home-country sovereign debt means accepting
riskier securities. One possibility is to accept highly rated privately issued bonds, such as covered
bonds. Another is to accept sovereign debt issued by other countries, although this will expose the
central bank to exchange rate risk. Central banks that accept a wide range of issuers and currency
denominations typically require both public and private collateral to be highly rated.
Collateral for Lending Facilities
Many central banks have lending facilities, sometimes called discount windows. As noted in our
previous post in this series, these facilities are expected to put a ceiling on the target interest rate.
The range of accepted collateral for standing liquidity facilities is often wider than acceptable
collateral for open market operations, and never narrower. For example, the Federal Reserve accepts
a much wider set of collateral at its discount windows than for its open market operations. In
contrast, the ECB and Norges Bank are examples of central banks that accept the same pool of
collateral against their discount windows and their market operations.
Haircuts on Eligible Collateral
To protect the central bank against the risk that the collateral will fall in value (in local currency
terms), central banks require the loans they make to be over-collateralized—meaning that the value
of the collateral exceeds the value of the loan. The amount of overcollateralization varies depending
on the risk associated with the collateral, including the exchange-rate risk when the collateral is
denominated in a foreign currency. These margins, or haircuts, are typically based on the observed
volatility in the market prices of the respective securities. Prior to the financial crisis, haircuts
typically varied from less than 1 percent to around 40 percent. For an example of a set of haircuts
see the Fed’s discount window haircuts.
Conclusion
Central banks conduct their lending through a limited number of counterparties and against
collateral. The main aims of these policies are to protect the central banks against risk of losses,
while ensuring implementation of monetary policy and smooth functioning of the payment system.
There is significant variation in the counterparty and collateral regimes put into place to achieve
these goals.
FEBRUARY 03, 2016
What Is the Composition of Central Bank Balance Sheets
in Normal Times?
Emily Eisner, Antoine Martin, and Ylva Søvik
There has been unusually high activity on central banks’ balance sheets in recent years. This activity,
which has expanded beyond the core operations and collateral of the central bank, has been called
“unconventional,” “nonstandard,” “nontraditional,” and “active.” But what constitutes a normal
central bank balance sheet? How does central bank asset and liability composition vary across
countries and how did the crisis change this composition? In this post, we focus on the main
characteristics of central bank balance sheets before the crisis. In our next piece, we describe how
this composition has changed in response to the crisis.
Central Bank Liabilities in Normal Times
The main liabilities of central banks are typically currency (banknotes) and reserves, a form of
money that can only be held by banks at the central bank (see the figure below). Banks use reserves
to make payments among themselves and to the central bank. In addition, some central banks issue
deposits to the government. These accounts function as the government’s “checking account” at the
central bank.
The Federal Reserve was a central bank that, before the crisis, held mostly currency as its main
balance sheet liability. Currency represented 93 percent of the Fed’s liabilities in December 2006,
with reserves only 1.5 percent and the Treasury’s general account half a percent. Currency is a sizable
liability on most central bank balance sheets in normal times.
Other central banks had a much larger share of their liabilities as reserves before the crisis. One
reason to issue a lot of reserves in normal times is to help interbank payments run smoothly; if the
supply of reserves is small, banks concerned about running out of reserves at the end of the day may
choose to delay payments to other banks, which can create “gridlock.”
As an example, the Norges Bank issued a relatively large amount of reserves before the crisis—7
percent of its liabilities. Almost 50 percent of the liability side of the Norges Bank balance sheet at
the end of 2006 was made up of treasury deposits, and currency represented only 16 percent of
liabilities, so its balance sheet looked more like the figure below.
Currency and reserves are “immediate” maturity liabilities, since they can be instantly transferred to
other parties for payment. Some central banks also issue term maturity liabilities, either term
deposits, which are only available to counterparties that hold a central bank account, or term repos,
which are collateralized and available to counterparties beyond depositing institutions. Some central
banks have the authority to issue bills. Like Treasury bills, central bank bills are available to
nonaccount holders in the secondary market, although some central banks restrict primary issue to
account holders. Term liabilities can be issued both to reduce the amount of reserves in the system
and to control the central bank’s target interest rate. (This composition is depicted in the figure
below.)
For instance, the Bank of England (BoE), the European Central Bank (ECB), the Fed, and the
Reserve Bank of Australia (RBA) have been fine-tuning term deposit facilities and repo instruments
that have longer maturities than overnight. The BoE, the ECB, the Swiss National Bank, and the RBA
are among the central banks that have the ability to issue bills, the Fed does not currently have this
authority.
Central Bank Assets in Normal Times
Central banks acquire assets by purchasing them or by making loans. When a central bank purchases
an asset, say a bond, it pays by creating reserves or currency, thus increasing its assets and liabilities
by equal amounts. Similarly, when a central bank extends a loan, it creates the new reserves that are
lent. Central banks’ counterparties are usually banks, although some accept nonbank counterparties
as described in yesterday’s post. In normal times, central banks hold mainly government bonds,
foreign exchange reserves, and loans to banks as assets. However, the relative importance of these
assets varies a lot across central banks. Prior to the crisis, changes to a central bank’s asset holdings
were typically passive and did not have a monetary policy purpose.
The Fed’s balance sheet before the crisis was relatively simple; at the end of 2006, nearly 90 percent
of its assets were U.S. Treasuries, broadly matching the amount of outstanding currency, as in the
figure below.
In contrast, central banks in small open economies tend to have a large share of foreign reserves on
their balance sheets, as in the figure below. This is partly due to history: When exchange rates were
fixed and capital flows regulated, large holdings of foreign reserves ensured that imports could be
funded, and made fixed exchange rates credible. With free capital flows and floating exchange rates,
these aims are less important, but central banks still sometimes intervene in foreign exchange
markets and need foreign reserves for this purpose. Furthermore, during financial stress, reserves
may be used to serve central bank customers such as the government, and to reduce the risk of
instability in financial systems heavily dependent on foreign currency funding. The importance of
these objectives will depend on each country’s need for interventions and the unhedged exposure of
its financial system to exchange rate risk. While reserve holdings are valuable in those stress
scenarios, the exchange rate risk to which it exposes the central bank could be higher than the
interest rate risk associated with holding government bonds. See this paper for further discussion of
the role of foreign reserves on central bank balance sheets.
The Norges Bank is an example of a central bank with a large share of foreign reserve holdings, with
86 percent of its assets (excluding the sovereign wealth fund) in this form at the end of 2006. In
comparison, the Fed held negligible foreign exchange reserves of about 4 percent.
Loans to banks can also be a sizable asset of central banks. This often happens when the central bank
holds few securities as assets, relative to the amount of its liabilities, notably currency. However,
sizable lending to the banking sector may occur even from central banks that hold a substantial
amount of securities against the currency. The loans may be useful to create reserves, as discussed
above, which can facilitate interbank payments. If the supply of reserves is low, central bank lending
to banks can make reserves available to support payments among banks. More than half the assets of
the BoE in December 2006 were loans to banks in the form of repos, and at the ECB, it was close to
40 percent of assets, as in the figure below. In comparison, only about 4 percent of Fed assets were
loans and repos at that time.
In some cases, a large share of bank loans on the central bank’s balance sheet may be an indication of
undeveloped money markets. This scenario requires the central bank to provide liquidity directly to
its banks, rather than let them redistribute the liquidity among themselves through the money
market.
To sum up, even in normal times the composition of central bank balances sheets can vary
considerably across countries. While all central banks issue two key forms of money, currency and
reserves, as liabilities, the relative size of these items can vary a lot. Some central banks also issue
deposits to the government and offer term liabilities, while others don’t. Assets typically consist of
government bonds, foreign reserves, and loans to banks, in varying proportions, but again, with
considerable variation across central banks.
FEBRUARY 04, 2016
How Do Central Bank Balance Sheets Change in Times of
Crisis?
Emily Eisner, Antoine Martin, and Ylva Søvik
The 2007-09 financial crisis, and the monetary policy response to it, have greatly increased the size
of central bank balance sheets around the world. These changes were not always well understood and
some were controversial. We discuss these crisis-induced changes, followingyesterday’s post on the
composition of central bank balance sheets in normal times, and explain the policy intentions behind
some of them.
Liabilities Composition during the Crisis
The primary change on the liability side of central banks’ balance sheets was a large build-up of
reserves available to the banking system. This happened in two phases. First, during the crisis itself,
many central banks around the world were active in supplying liquidity to shaky financial systems.
Second, post crisis, several central banks began pursuing unprecedented quantitative easing (QE)
policies by purchasing large quantities of certain types of assets from the private sector to boost their
struggling economies. The increase in reserves was, in many cases, a by-product of the policies these
central banks were pursuing, as we explain below.
During the crisis, central banks typically extended loans to banks, and sometimes less traditional
counterparties, to support financial stability. These loans provided much needed liquidity to banks
and other financial intermediaries and increased the amount of reserves. For example, in the United
States, during 2008, reserves increased from $13 billion to almost $850 b
