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

Author

Listed:
  • Acharya, Viral
  • Chauhan, Rahul
  • Rajan, Raghuram
  • Steffen, Sascha

Abstract

When the Federal Reserve (Fed) expands its balance sheet via quantitative easing (QE), we show commercial banks finance their reserve holdings with demandable deposits, especially uninsured ones, and also issue lines of credit to corporations. These bank-issued claims on liquidity did not shrink when the Fed halted its balance-sheet expansion in 2014 and eventually actively reversed it during quantitative tightening (QT) starting in 2017. Consequently, the financial sector, especially smaller and less-well-capitalized banks that increased their liquidity risk exposure more, became vulnerable to potential liquidity shocks. This in turn has necessitated further liquidity provision by the Fed, as witnessed in September 2019 (repo rate spike), March 2020 (dash for cash due to COVID-19 outbreak), and March 2023 (uninsured depositor runs on banks). The evidence suggests that the expansion and shrinkage of central bank balance sheets leads to liquidity dependence in the financial system, suggesting potential tradeoffs between monetary policy and financial stability.

Suggested Citation

  • Acharya, Viral & Chauhan, Rahul & Rajan, Raghuram & Steffen, Sascha, 2022. "Liquidity Dependence and the Waxing and Waning of Central Bank Balance Sheets," CEPR Discussion Papers 17622, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17622
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    Cited by:

    1. Christian Bittner & Alexander Rodnyansky & Farzad Saidi & Yannick Timmer, 2021. "Mixing QE and Interest Rate Policies at the Effective Lower Bound: Micro Evidence from the Euro Area," CESifo Working Paper Series 9363, CESifo.
    2. Chavleishvili, Sulkhan & Kremer, Manfred & Lund-Thomsen, Frederik, 2023. "Quantifying financial stability trade-offs for monetary policy: a quantile VAR approach," Working Paper Series 2833, European Central Bank.
    3. Francesco Casalena, 2024. "Back to normal? Assessing the Effects of the Federal Reserve's Quantitative Tightening," IHEID Working Papers 14-2024, Economics Section, The Graduate Institute of International Studies.
    4. Chavleishvili, Sulkhan & Kremer, Manfred & Lund-Thomsen, Frederik, 2024. "Quantifying financial stability risks for monetary policy," Research Bulletin, European Central Bank, vol. 115.
    5. Cappelletti, Giuseppe & Marqués-Ibáñez, David & Reghezza, Alessio & Salleo, Carmelo, 2024. "As interest rates surge: flighty deposits and lending," Working Paper Series 2923, European Central Bank.
    6. Fricke, Daniel & Greppmair, Stefan & Paludkiewicz, Karol, 2024. "Excess reserves and monetary policy tightening," Discussion Papers 05/2024, Deutsche Bundesbank.
    7. Bryan Hardy & Sonya Zhu, 2023. "Unpacking international banks' deposit funding," BIS Quarterly Review, Bank for International Settlements, September.

    More about this item

    Keywords

    Monetary policy; Federal Reserve; Quantitative easing; Financial stability; Deposits; Financial fragility; Large-scale asset purchases; Quantitative tightening; Fed normalization; Lines of credit;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G01 - Financial Economics - - General - - - Financial Crises
    • G2 - Financial Economics - - Financial Institutions and Services

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