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Liquidity, liquidity everywhere, not a drop to use - Why flooding banks with central bank reserves may not expand liquidity

Author

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  • Acharya, Viral
  • Rajan, Raghuram

Abstract

Central bank balance sheet expansion is financed by commercial banks. Apart from substituting liquid central bank reserves for other assets held by commercial banks, which enhances the availability of liquidity, it entails an increase in commercial bank liabilities, such as demandable deposits, issued to finance reserves. Banks typically also write other claims on reserve holdings. During future episodes of stress when many claims on liquidity are exercised and surplus banks hoard reserves, the demand for liquidity can exceed available reserves, exacerbating liquidity stress. This may attenuate any positive monetary effects of reserve expansion on economic activity.

Suggested Citation

  • Acharya, Viral & Rajan, Raghuram, 2022. "Liquidity, liquidity everywhere, not a drop to use - Why flooding banks with central bank reserves may not expand liquidity," CEPR Discussion Papers 16907, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16907
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    Cited by:

    1. Jan Marc Berk & Jan Willem van den End, 2022. "Excess Liquidity and the Usefulness of the Money Multiplier," Credit and Capital Markets – Kredit und Kapital, Duncker & Humblot, Berlin, vol. 55(4), pages 457-488.
    2. Girotti, Mattia & Horny, Guillaume, 2023. "Monetary policy transmission through banks when liquidity is abundant but unevenly distributed," Finance Research Letters, Elsevier, vol. 56(C).
    3. Duncan, Elizabeth & Horvath, Akos & Iercosan, Diana & Loudis, Bert & Maddrey, Alice & Martinez, Francis & Mooney, Timothy & Ranish, Ben & Wang, Ke & Warusawitharana, Missaka & Wix, Carlo, 2022. "COVID-19 as a stress test: Assessing the bank regulatory framework," Journal of Financial Stability, Elsevier, vol. 61(C).
    4. Xiong, Wanting & Wang, Yougui, 2022. "A reformulation of the bank lending channel under multiple prudential regulations," Economic Modelling, Elsevier, vol. 114(C).
    5. Matthew Schaffer & Nimrod Segev, 2023. "Quantitative Easing, Bank Lending, and Aggregate Fluctuations," Bank of Israel Working Papers 2023.01, Bank of Israel.
    6. Gara Afonso & Domenico Giannone & Gabriele La Spada & John C. Williams, 2022. "Scarce, Abundant, or Ample? A Time-Varying Model of the Reserve Demand Curve," Staff Reports 1019, Federal Reserve Bank of New York.
    7. Böhl, Gregor, 2022. "Endogenous Money, Excess Reserves and Unconventional Monetary Policy," VfS Annual Conference 2022 (Basel): Big Data in Economics 264141, Verein für Socialpolitik / German Economic Association.

    More about this item

    Keywords

    Quantitative easing; Central bank balance sheet; Financial stability; Repo rate spike; Liquidity hoarding; Liquidity dependence; Margin requirements; Capital requirements;
    All these keywords.

    JEL classification:

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

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