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  5. Uses and Limits of Central Bank Balance Sheets
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Uses and Limits of Central Bank Balance Sheets

Paper Session

Sunday, Jan. 7, 2024 10:15 AM - 12:15 PM (CST)

Grand Hyatt, Lone Star Ballroom Salon D
Hosted By: American Economic Association
  • Chair: Hyun Song Shin, Bank for International Settlements

The anatomy of a peg: lessons from China’s parallel currencies

Ricardo Reis
,
London School of Economics
Saleem Bahaj
,
University College London

Abstract

China’s current account transactions use an offshore international currency, the CNH, that co-exists as a parallel currency with the mainland domestic currency, the CNY. The CNH is freely used, but by restricting its exchange for CNY, the authorities can enforce capital controls. Sustaining these controls requires tight management of the money supply and liquidity to keep the exchange rate between the dual currencies pegged. After describing how the central bank implements this system, we find a rare instance of identified, exogenous, transitory increases in the supply of money and show that they depreciate the exchange rate. Theory and evidence show that elastically supplying money and using liquidity policies can maintain a currency peg. In turn, deviations from the CNH/CNY peg can be used as a pressure valve to manage the exchange rate between the yuan and the US dollar and avoid liquidity controls.

Liquidity Dependence and the Waxing and Waning of Central Bank Balance Sheets

Viral Acharya
,
New York University
Rahul S. Chauhan
,
University of Chicago
Raghuram Rajan
,
University of Chicago
Sascha Steffen
,
Frankfurt School of Finance and Management

Abstract

When the Federal Reserve (Fed) expanded its balance sheet via quantitative easing (QE), commercial banks financed reserve holdings with deposits and reduced their average maturity. They also issued lines of credit to corporations. However, when the Fed halted its balance-sheet expansion in 2014 and even reversed it during quantitative tightening (QT) starting in 2017, there was no commensurate shrinkage of these claims on liquidity. Consequently, the financial sector was left more sensitive to potential liquidity shocks, with weaker-capitalized banks most exposed. This necessitated Fed liquidity provision in September 2019 and again in March 2020. Liquidity-risk-exposed banks suffered the most drawdowns and the largest stock price declines at the onset of the Covid crisis in March 2020. The evidence suggests that the expansion and shrinkage of central bank balance sheets involves tradeoffs between monetary policy and financial stability.

The Bank of Amsterdam and the Limits of Fiat Money

Wilko Bolt
,
De Nederlandsche Bank
Jon Frost
,
Bank for International Settlements
Hyun Song Shin
,
Bank for International Settlements
Peter Wierts
,
De Nederlandsche Bank

Abstract

Central banks can operate with negative equity, and many have done so in history without undermining trust in fiat money. However, there are limits. How negative can central bank equity be before fiat money loses credibility? We address this question using a global games approach motivated by the fall of the Bank of Amsterdam (1609–1820). We solve for the unique break point where negative equity and asset illiquidity renders fiat money worthless. We draw lessons on the role of fiscal support and central bank capital in sustaining trust in fiat money.

Exorbitant Privilege Gained and Lost: Fiscal Implications

Zefeng Chen
,
Peking University
Zhengyang Jiang
,
Northwestern University
Hanno N. Lustig
,
Stanford University
Stijn Van Nieuwerburgh
,
Columbia University
Mindy Z. Xiaolan
,
University of Texas

Abstract

We study three centuries of U.K., U.S. and Dutch fiscal history. When a country is the dominant safe asset supplier, its sovereign debt is more expensive relative to other sovereign debt, and it can issue more debt than what is justified by its future primary surpluses. This pattern holds for the Dutch Republic in the 17th and 18th, the U.K. in the 18th and 19th, and the U.S. in the 20th and 21st centuries. When the Dutch Republic's and the U.K.'s fiscal fundamentals deteriorated, they lost their dominant position as the safe asset supplier. Since then, their debt has been fully backed by their primary surpluses. These results support theories of safe asset determination in which investors concentrate extra fiscal capacity in a single safe asset supplier based on relative macro fundamentals, allowing its debt to exceed its fiscal backing.

Discussant(s)
Leonardo Gambacorta
,
Bank for International Settlements
Sarah Bell
,
Bank for International Settlements
Chris Erceg
,
International Monetary Fund
Maxime Sauzet
,
Boston University
JEL Classifications
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
  • E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook