The Central Bank's Balance Sheet in the Long Run: A Macro Perspective

33 Pages Posted: 3 Oct 2024

See all articles by Peter Karadi

Peter Karadi

European Central Bank (ECB)

Dominik Thaler

European Central Bank (ECB); Banco de España

Oreste Tristani

European Central Bank (ECB)

Date Written: August, 2024

Abstract

We study whether it is desirable for the central bank to supply reserves abundantly, i.e. beyond the level that satisfies financial institutions’ aggregate liquidity needs. Using a theoretical framework, we demonstrate that abundant reserves would help fulfil the private sector’s demand for safe and liquid assets, because reserves affect financial institutions’ leverage constraints. More specifically, systematic central bank purchases of medium-term government bonds from financial institutions would relax those institutions’ leverage constraints and allow them to expand their balance sheets and issue more private liquidity, in the form of deposits. However, a very large increase in the average size of its balance sheet would expose the central bank to the risk of large financial losses. On balance, only amoderately larger supply of reserves than the level that satisfies financial institutions’ aggregate liquidity needs appears desirable.

Keywords: central bank reserves, Friedman rule, liquidity policy

JEL Classification: E41, E44, E58

Suggested Citation

Karadi, Peter and Thaler, Dominik and Tristani, Oreste, The Central Bank's Balance Sheet in the Long Run: A Macro Perspective (August, 2024). ECB Working Paper No. 2024/25, Available at SSRN: https://ssrn.com/abstract=4975240 or http://dx.doi.org/10.2139/ssrn.4975240

Peter Karadi (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Dominik Thaler

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Oreste Tristani

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0049 69 1344 6000 (Fax)

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