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

57 Pages Posted: 26 Jan 2022 Last revised: 18 Aug 2023

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)

Raghuram G. Rajan

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

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Date Written: August 15, 2023

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.

JEL Classification: E0,G0

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Rajan, Raghuram G., Liquidity, Liquidity Everywhere, Not a Drop to Use: Why Flooding Banks with Central Bank Reserves May Not Expand Liquidity (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

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