Working Paper: CEPR ID: DP10741
Authors: Robert E. Hall; Ricardo Reis
Abstract: Since 2008, the central banks of advanced countries have borrowed trillions of dollarsfrom their commercial banks in the form of interest-paying reserves and invested theproceeds in portfolios of risky assets. We investigate how this new style of centralbanking a ects central banks' solvency. A central bank is insolvent if its requirementto pay dividends to its government exceeds its income by enough to cause an unendingupward drift in its debts to commercial banks. We consider three sources of riskto central banks: interest-rate risk (the Federal Reserve), default risk (the EuropeanCentral Bank), and exchange-rate risk (central banks of small open economies). Wend that a central bank that pays dividends equal to a standard concept of net incomewill always be solvent|its reserve obligations will not explode. In some circumstances,the dividend will be negative, meaning that the government is making a payment tothe bank. If the charter does not provide for payments in that direction, then reserveswill tend to grow more in crises than they shrink in normal times. To prevent thisbuildup, the charter needs to provide for makeup reductions in payments from thebank to the government. We compute measures of the nancial strength of centralbanks, and discuss how di erent institutions interact with quantitative easing policiesto put these banks in less or more danger of instability. We conclude that the risks tonancial stability are real in theory, but remote in practice today.
Keywords: Central Bank Capital; Central Bank Solvency; Monetary Policy; Quantitative Easing
JEL Codes: E42; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Central Bank Dividend Payments (E58) | Central Bank Solvency (E58) |
| Central Bank Dividend Payments (E58) | Ponzi Scheme Risk (G24) |
| Federal Reserve Interest Rate Risks (E43) | Federal Reserve Financial Stability (G28) |
| Bond Pricing (G12) | European Central Bank Financial Stability (E58) |
| Central Bank Foreign Reserves (F31) | Volatile Net Income (G19) |
| Volatile Net Income (G19) | Central Bank Stability (E58) |