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May 24, 2012
The relative expansion of central banks’ balance sheets
Dave Altig's recent macroblog post on policy actions that affected the Fed's balance sheet made me wonder about how changes to the Fed's balance sheet since the financial crisis compared with other central banks.
Relative to before the financial crisis, the Federal Reserve's asset holdings are currently about 3.3 times larger. Initially, the source of that increase was the collateral associated with various temporary lending facilities that the Fed used to address the financial panic. Those assets were then replaced on net by purchases under the first large-scale asset purchase program in 2009. Then in late 2010, asset holdings increased further as a result of a second large-scale asset purchase program.
Of course, size isn't everything. While it might be tempting to try and interpret the change in the size of the central bank's balance sheet as a summary statistic of the degree of monetary policy accommodation, as Dave Altig's post points out, that interpretation is not so straightforward. Increasing the size of the balance sheet is not the only thing a central bank can do to ease monetary policy when short-term interest rates are very low. For example, in late 2011 the Fed began a maturity extension program that changed the composition of the assets on the balance sheet, but this program did not materially alter the size of the balance sheet.
With this caveat in mind, the following chart compares the proportionate changes in the size of asset holdings of five central banks over the period from the first quarter of 2007 through the first quarter of 2012: the Federal Reserve (FR), the Bank of England (BE), the European Central Bank (ECB), the Bank of Canada (BC), and the Bank of Japan (BJ).
One take-away from the chart is the large variation from country to country. Here are some observations:
- Bank of England: Through mid-2011, the proportionate increase in the Bank of England's asset holdings was roughly similar to the Fed's. But then the Bank of England began a second round of large scale asset purchases that sharply increased the size of its balance sheet. By the first quarter of 2012, the Bank of England's asset holdings were about 4.2 times as large as they were before the financial crisis.
- European Central Bank: Through mid-2011, the ECB's asset holdings were about 1.7 times their precrisis level. But the sharp increase in the ECB's longer-term lending programs in recent months has resulted in a large increase in the size of ECB's balance sheet. By the first quarter of 2012, the ECB's asset holdings were about 2.5 times what they were before the financial crisis.
- Bank of Canada: In 2009, the Bank of Canada's asset holdings had increased to about 1.6 times their precrisis level—similar to the ECB's increase. But as liquidity pressures in Canadian financial markets eased, the Bank of Canada's asset holdings declined in 2010. By the first quarter of 2012, the Bank of Canada's asset holdings were around 1.3 times the precrisis level. (Note that the Bank of Canada's asset data are through February 2012.)
- Bank of Japan: The balance sheet of the Bank of Japan did not increase materially during the financial crisis, but has increased somewhat over the last year. By the first quarter of 2012 the Bank of Japan's asset holdings were about 1.2 times the pre-crisis level.
While size isn't everything, it is something. A large expansion in a central bank's balance sheets can create broad policy risks. This study by researchers at the St. Louis Fed suggests that large-scale balance sheet increases are a viable monetary policy tool, provided the public believes the increase will be appropriately reversed (citing the experience of Nordic countries in the early 1990s) or that the reserves created by the expansion will remain within the banking system (citing changes to bank settlement systems in the United Kingdom and New Zealand in the mid-2000s). New York Fed President Bill Dudley touched on some risks in an interview on CNBC today:
"...We've expanded our balance sheet a lot over the last few years. And additional actions do have costs, and so we have to weight them relative to the benefits...
"One set of cost is the extent we expand our balance sheet or we sell short-dated treasury securities and buy long-dated treasury securities, we have more risk, in terms of our portfolio, interest rate risks...
"The second issue, of course, is if we expand our balance sheet, we could create anxiety among some people that this might actually sow the seeds for future inflation. I don't think expansion of the balance sheet, in any way, compromises the Fed's ability to keep inflation in check over the longer term. But it doesn't matter just what I think. If people in the market think that expansion of the balance sheet could cause future inflation, we have to take those expectations into consideration as a potential cost of monetary policy."
John Robertson, vice president and senior economist in the Atlanta Fed's research department
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