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Surplus Liquidity: Implications for Central Banks

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  • Joe Ganley
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    Abstract

    Surplus liquidity occurs where cashflows into the banking system persistently exceed withdrawals of liquidity from the market by the central bank. This is reflected in holdings of reserves in excess of the central bank's required reserves. The occurrence of surplus liquidity is widespread, covering many countries around the world. Historically, it has been observed most often in Soviet, wartime and transitional countries. Transitional economies, for example, often attract large capital inflows as the economy opens and undergoes privatisation. The effect of these inflows on liquidity is often magnified by central bank intervention in the foreign exchange market when there is upward pressure on the domestic currency. In the wartime economy, consumption is restricted and large amounts of involuntary savings accumulate until goods and services eventually become more widely available. Soviet-style economies have displayed widespread shortages and administered prices. This creates a situation of repressed inflation, whereby prices are too low relative to the money stock, leaving individuals with excess real balances. The importance of surplus liquidity for central banks is threefold and lies in its potential to influence: (1) the transmission mechanism of monetary policy; (2) the conduct of central bank intervention in the money market, and (3) the central bank's balance sheet and income.

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    This book is provided by Centre for Central Banking Studies, Bank of England in its series Lectures with number 3 and published in 2004.

    Handle: RePEc:ccb:lectur:3

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    Keywords: Surplus Liquidity; Implications; Central Banks;

    References

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    1. Baltensperger, Ernst, 1980. "Alternative approaches to the theory of the banking firm," Journal of Monetary Economics, Elsevier, vol. 6(1), pages 1-37, January.
    2. Atish R. Ghosh & Anne-Marie Gulde & Holger C. Wolf, 2000. "Currency boards: More than a quick fix?," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 15(31), pages 269-335, October.
    3. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
    4. Peter Stella, 1997. "Do Central Banks Need Capital?," IMF Working Papers 97/83, International Monetary Fund.
    5. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(1), pages 26-56, February.
    6. Di Giorgio, Giorgio, 1999. "Financial development and reserve requirements," Journal of Banking & Finance, Elsevier, vol. 23(7), pages 1031-1041, July.
    7. de Bondt, Gabe, 2002. "Retail bank interest rate pass-through: new evidence at the euro area level," Working Paper Series 0136, European Central Bank.
    8. Glenn Hoggarth, 1996. "Introduction to Monetary Policy," Handbooks, Centre for Central Banking Studies, Bank of England, Centre for Central Banking Studies, Bank of England, number 1.
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    Cited by:
    1. Pierre-Richard Agénor & Karim El Aynaoui, 2008. "Excess Liquidity, Bank Pricing Rules, and Monetary Policy," Centre for Growth and Business Cycle Research Discussion Paper Series 105, Economics, The Univeristy of Manchester.
    2. Muhammad, Omer & de Haan, Jakob & Scholtens, Bert, 2014. "An Empirical Analysis of Excess Interbank Liquidity: A Case Study of Pakistan," MPRA Paper 56143, University Library of Munich, Germany.

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