Working Paper: CEPR ID: DP17858
Authors: Niall Ferguson; Martin Kornejew; Paul Schmelzing; Moritz Schularick
Abstract: This paper studies the evolution of central bank balance sheets over the past 400 years across 17 major economies. The size of central bank balance sheets has varied substantially over time relative to economic and financial activity. Major balance sheet expansions were initially associated with government finance in geopolitical emergencies, but over time liquidity provision during financial turmoil has become the key driver of balance sheet operations. We examine the historical record of such lender of last resort interventions with a novel identification strategy based on pre-determined ideological beliefs of acting central bank governors ("hawks" vs. "doves") with respect to financial sector support. Using exogenous variation in the crisis response, we estimate the effects of lender of last resort operations on the economy. History shows that liquidity support during financial crises has indeed tended to stabilize the economy successfully: crises are less severe, asset prices recover more quickly, and deflation is avoided. However, there is also evidence that the provision of central bank liquidity to financial markets raises the probability of future boom-bust episodes, pointing to potential moral hazard effects of central bank intervention.
Keywords: central bank balance sheet; financial crises; liquidity support; moral hazard
JEL Codes: G01; G15; G21; N20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| central bank liquidity support (E58) | stabilization of the economy during crises (E63) |
| central bank liquidity support (E58) | less severe downturns (E32) |
| central bank liquidity support (E58) | faster recovery of asset prices (G19) |
| central bank liquidity support (E58) | avoidance of deflation (E31) |
| central bank balance sheet expansion of at least 15% (E59) | significant boost in real GDP (E20) |
| central bank liquidity support (E58) | probability of future boom-bust cycles (E32) |