“Less is more” or “Less is a bore”? Re-calibrating the role of central bank reserves


Central banks today face many challenges – but three of the biggest are:

  • First, how to judge where central bank balance sheets should settle in the medium term as monetary policy makers return inflation – which remains far too high – to target, through a combination of higher interest rates and unwinding Quantitative Easing (QE) and other ‘unconventional’ policy interventions;
  • Second, on the micro-prudential side, how to ensure that banks’ liquidity insurance remains appropriate as technological change increases the risk of larger and faster deposit runs, of the kind seen this Spring in the US; and
  • Third, on the macro-prudential side, how to ensure the stability of the financial system as a whole in the face of the growing incidence of systemic liquidity shocks, not just in banks but increasingly in non-bank market finance too.

These questions span the full width of the central banking remit – and their discussion therefore usually involve different people, with different goals, analytical frameworks and policy tools. But there is one important common factor – and that is central bank reserves, the ultimate form of settlement and hence the safest and most liquid of all financial assets. In most economies, including the UK, the stock of reserves has risen materially over the past 15 years as the result of ‘unconventional’ monetary easing. As that process reverses, the question is what contribution should reserves make to maintaining micro- and macro-prudential stability, given the changing nature of risks to those goals?

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