FRANKFURT (Reuters) – The Federal Reserve and the European Central Bank (ECB) could withdraw up to 90% of the cash they have pumped into banks over the past decade as inflation and higher interest rates high making those additional funds useless, according to an article by a Fed economist published Thursday.
The world’s two largest central banks raised interest rates at a brisk pace to fight inflation and ended some of their massive bond-buying programs, which flooded banks with liquidity as they that price growth was weak and borrowing costs were already at zero.
The Fed’s paper, which will be presented to key central bankers next week at the ECB’s annual meeting in Portugal, asks how much liquidity the Fed and ECB should keep in the banking system to meet the need for reserves now that monetary stimulus is no longer needed.
The economist, senior adviser to the Federal Reserve, estimates that the Fed could reduce the volume of reserves that are deposited with the central bank from 6,000 billion dollars to an amount between 600 and 3,300 billion dollars, depending on the assets that she will accept – US government bonds or less coveted securities.
US and German sovereign securities command a premium in the market because of their liquidity and safety, meaning banks have less incentive to exchange them for central bank deposits.
Similarly, the ECB could reduce its own reserves, currently at 4.1 trillion euros, to 521 billion euros if it accepts only German government bonds, or to 1.4 trillion euros if it accepts more. ‘assets.
Neither of these scenarios is plausible in the short term, as both the Fed and the ECB have a mixture of government bonds and other types of debt on their balance sheets.
The study focuses on the supply and demand of reserves and the relative interest of assets received by central banks in exchange, but does not take into account other variables.
The ECB, for example, is beginning to debate whether to change its current framework, in which reserves are plentiful and borrowing costs for banks are set at the interest rate the central bank pays on deposits.
The paper also fails to take into account the potential side effects of a large balance sheet, such as inflation in the price of certain assets or less pressure on governments to pursue sound fiscal policy.
“I view my estimates as a benchmark from which policymakers can adjust the size of the balance sheet up or down depending on their view and the importance of other factors,” writes Annette Vissing-Jorgensen, the author of the study, in her document.
(Report Francesco Canepa, French version Corentin Chapron, edited by Kate Entringer)
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