The Leibniz Institute for Financial Research SAFE organizes a seminar on
Liquidity Dependence and the Waxing and Waning of Central Bank Balance Sheets
Viral Acharya, New York University, Stern School of Business
joint work with Rahul Chauhan, Raghuram Rajan and Sascha Steffen,
August 2022, revised March 2023
Download PDF, Download Online Appendix, Download Slides
to be held on 8 May, 15:00 – 16:15 CEST, SAFE Common Room HoF 1.01, House of Finance
When the Federal Reserve (Fed) expanded its balance sheet via quantitative easing (QE), commercial banks financed reserve holdings with deposits, especially uninsured ones, and reduced their average maturity. They also issued lines of credit to corporations. However, when the Fed halted its balance-sheet expansion in 2014 and even reversed it during quantitative tightening (QT) starting in 2017, there was no commensurate shrinkage of these claims on liquidity. Consequently, the financial sector was left more sensitive to potential liquidity shocks, with lower-capitalized banks most exposed. This necessitated Fed liquidity provision in September 2019 and again in March 2020. Liquidity-risk-exposed banks suffered the most drawdowns and the largest stock price declines at the onset of the Covid crisis in March 2020.
The evidence suggests that the expansion and shrinkage of central bank balance sheets involves tradeoffs between monetary policy and financial stability, as also evidenced in recent banking stress and runs by uninsured bank depositors.
An earlier draft of the paper was circulated under the title "Liquidity Dependence: Why Shrinking Central Bank Balance Sheets is an Uphill Task", August 2022, as prepared for the Federal Reserve Bank of Kansas City Jackson Hole Economic Symposium 2022 on Reassessing Constraints on the Economy and Policy, download remarks.
Covered in Bloomberg and Fortune (August 27, 2022), Op-eds "Where has all the liquidity gone?" in Project Syndicate (Oct, 7, 2022), "Quantitative Easing Left the Banking System Vulnerable" in Barron's (March 17, 2023), "The Fed and Bank Failures" in ProMarket (March 28, 2023), "The Fed's Role in the Bank Failures" in Project Syndicate (March 28, 2023), "Bank Failures: What's the Fed's role?" in Ideas For India (March 31, 2023), all with Raghuram Rajan.
