Working Paper: NBER ID: w31050
Authors: Viral V. Acharya; Rahul S. Chauhan; Raghuram Rajan; Sascha Steffen
Abstract: When the Federal Reserve (Fed) expands its balance sheet via quantitative easing, commercial banks finance their reserve holdings with demandable deposits, especially uninsured ones, and also issue lines of credit to corporations. These bank-issued claims on liquidity did not shrink when the Fed halted and eventually reversed its balance-sheet expansion in 2014-2019. Consequently, the financial sector, especially banks that increased their liquidity risk exposure more, became vulnerable to shocks. This in turn has necessitated further liquidity provision by the Fed, as witnessed in September 2019, March 2020, and March 2023, suggesting potential tradeoffs between unconventional monetary policy and financial stability.
Keywords: Liquidity Dependence; Central Bank Balance Sheets; Quantitative Easing; Financial Stability
JEL Codes: G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Expansion of the Fed's balance sheet through QE (E52) | Increase in demandable claims on liquidity (E41) |
| Increase in reserves (F31) | Increase in demandable claims on liquidity (E41) |
| Shrinkage of the Fed's balance sheet during QT (E49) | No corresponding decrease in liquidity claims (G19) |
| Greater liquidity claims relative to reserves (E51) | Larger stock price declines during COVID crisis (G19) |
| Increase in reserves (F31) | Greater liquidity risk exposure among banks (F65) |