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Liquidity, Liquidity Everywhere, Not a Drop to Use – Why Flooding Banks with Central Bank Reserves May Not Expand Liquidity

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  • Viral V. Acharya
  • Raghuram Rajan

Abstract

Central bank balance sheet expansion is run through commercial banks. While liquid central bank reserves held on commercial bank balance sheets increase, demandable uninsured deposits issued to finance the reserves also increase. A subsequent shrinkage in the central bank balance sheet may entail a shrinkage in bank-held reserves without a commensurate reduction in deposit claims. Furthermore, during episodes of liquidity stress, when many claims on liquidity are called, surplus banks may hoard reserves. As a result of such bank behavior, central bank balance sheet expansion may create less systemic liquidity than typically thought, and in fact, the demand for liquidity can occasionally exceed available reserves, exacerbating liquidity stress.

Suggested Citation

  • Viral V. Acharya & Raghuram Rajan, 2022. "Liquidity, Liquidity Everywhere, Not a Drop to Use – Why Flooding Banks with Central Bank Reserves May Not Expand Liquidity," NBER Working Papers 29680, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:29680
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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. 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.
    3. Girotti, Mattia & Horny, Guillaume, 2023. "Monetary policy transmission through banks when liquidity is abundant but unevenly distributed," Finance Research Letters, Elsevier, vol. 56(C).
    4. 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.
    5. 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.
    6. 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).
    7. Xiong, Wanting & Wang, Yougui, 2022. "A reformulation of the bank lending channel under multiple prudential regulations," Economic Modelling, Elsevier, vol. 114(C).
    8. Matthew Schaffer & Nimrod Segev, 2023. "Quantitative Easing, Bank Lending, and Aggregate Fluctuations," Bank of Israel Working Papers 2023.01, Bank of Israel.

    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • G0 - Financial Economics - - General

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