BIS getting there (yet not fully)

Yes, his causation is off on the less important point of the central bank eliminating opportunity costs when in fact market forces eliminate opportunity cost as they express indifference levels to central bank rate policies.

But apart from that it’s very well stated and what we’ve been saying all along, thanks!!! The highlighted part is especially on message and hopefully becomes common knowledge.

Jaime Caruana, General Manager of the BIS says ‘unconventional
measures’ do not increase lending, nor are inflationary:

In fact, bank lending is determined by banks’ willingness to grant
loans, based on perceived risk-return trade-offs, and by the demand
for those loans. An expansion of reserves over and above the level
demanded for precautionary purposes, and/or to satisfy any reserve
requirement, need not give banks more resources to expand lending.
Financing the change in the asset side of the central bank balance
sheet through reserves rather than some other short-term instrument
like central bank or Treasury bills only alters the composition of the
liquid assets of the banking system. As noted, the two are very close
substitutes. As a result, the impact of variations in this composition
on bank behaviour may not be substantial.

This can be seen another way. Recall that in order to finance balance
sheet policy through an expansion of reserves the central bank has to
eliminate the opportunity cost of holding them. In other words, it
must either pay interest on reserves at the positive overnight rate
that it wishes to target, or the overnight rate must fall to the
deposit facility floor (or zero). In effect, the central bank has to
make bank reserves sufficiently attractive compared with other liquid
assets. This makes them almost perfect substitutes, in particular for
other short-term government paper. Reserves become just another type
of liquid asset among many. And because they earn the market return,
reserves represent resources that are no more idle than holdings of
Treasury bills.

(…) What about the concern that large expansions in bank reserves
will lead to inflation – the second issue? No doubt more accommodative
financial conditions resulting from central bank lending and asset
purchases, insofar as they stimulate aggregate demand, can generate
inflationary pressures. But the point I would like to make here is
that there is no additional inflationary effect coming from an
increase in reserves per se. When bank reserves are expanded as part
of balance sheet policies, they should be viewed as simply another
form of liquid asset that is comparable to short-term government
paper. Thus funding balance sheet policies with reserves should be no
more inflationary than, for instance, the issuance of short-term
central bank bills.


(…) Ultimately, any inflationary concerns associated with
monetisation should be mainly attributed to the monetary authorities’
accommodating fiscal deficits by refraining from raising rates. In
other words, it is not so much the financing of government spending
per se – be it in the form of bank reserves or short-term sovereign
paper – that is inflationary, but its accommodation at inappropriately
low interest rates for too long a time. Critically, these two aspects
are generally lumped together in policy debates because the prevailing
paradigm has failed to distinguish changes in interest rate from
changes in the amount of bank reserves in the system. One is seen as
the dual of the other: more reserves imply lower interest rates. As I
explained earlier, this is not the case. While both the central bank’s
balance sheet size and the level of reserves will reflect an
accommodating policy, neither serves as a summary measure of the
stance of policy.

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2 Responses to BIS getting there (yet not fully)

  1. Panayotis says:

    Warren,

    Interest rates follow they do not lead. Deficit spending is not inflationary as long as a) it is automatic (stabilization) below full employment of resources and b) voluntary (discretionary)towards public investment in human capital, skills development, technology/innovation that raises productivity even at full employment. Short term rates follow CB policy and long term rates a number of factors including inflationary expectations, uncertainty, animal spirits, etc. Actually against mainstream theory deficit spending is inversely related with long term rates.

    Reply

  2. Ramanan says:

    There are two GAO.gov articles I found a few days back which give a lot of good information about the Treasury’s cash balances and management. It makes good observations – so gets it right in many places.

    http://www.gao.gov/new.items/d071105.pdf
    http://www.gao.gov/new.items/d061007.pdf

    Good info on what the Treasury did during stressful events such as 9/11.

    Reply

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