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

61 Pages Posted: 26 Jan 2022 Last revised: 1 Dec 2024

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Rahul Singh Chauhan

University of Chicago - Booth School of Business

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Sascha Steffen

Frankfurt School of Finance & Management; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 4 versions of this paper

Date Written: August 15, 2023

Abstract

When the Federal Reserve (Fed) expanded its balance sheet via quantitative easing (QE), commercial banks typically financed reserve holdings with uninsured demandable deposits. They also issued credit lines to corporations. In the aggregate, these bank-issued claims on liquidity did not shrink commensurately when the Fed halted QE and turned to quantitative tightening (QT). Consequently, banks that increased liquidity risk exposure – especially small and regional banks – became vulnerable to liquidity shocks, necessitating further liquidity provision by the Fed. The evidence suggests that the expansion and shrinkage of central bank balance sheets has led to liquidity dependence of banks on central banks. 

Keywords: Federal Reserve, quantitative easing, large-scale asset purchases, quantitative tightening, Fed normalization, demandable deposits, uninsured deposits, lines of credit, financial stability, unconventional monetary policy.

JEL Classification: E0,G0

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Chauhan, Rahul Singh and Rajan, Raghuram G. and Steffen, Sascha, Liquidity Dependence and the Waxing and Waning of Central Bank Balance Sheets (August 15, 2023). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2022-19, Available at SSRN: https://ssrn.com/abstract=4017741 or http://dx.doi.org/10.2139/ssrn.4017741

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business ( email )

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New York University (NYU) - Department of Finance ( email )

Stern School of Business
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Centre for Economic Policy Research (CEPR) ( email )

London
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National Bureau of Economic Research (NBER) ( email )

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Rahul Singh Chauhan

University of Chicago - Booth School of Business ( email )

Chicago
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Raghuram G. Rajan (Contact Author)

University of Chicago - Booth School of Business ( email )

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International Monetary Fund (IMF) ( email )

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National Bureau of Economic Research (NBER)

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Sascha Steffen

Frankfurt School of Finance & Management ( email )

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HOME PAGE: http://www.sascha-steffen.de

Centre for Economic Policy Research (CEPR) ( email )

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