Chapter 11
Conclusion
The hard economic blow arising from the global financial crisis pushed central banks to adopt unconventional monetary policy tools. These tools were initially utilized to prevent deeper financial destabilization and bankruptcy of solvent-but-illiquid private sector balance sheets, and subsequently to address economic stagnation and deflation risks. Central banks such as the U.S. Federal Reserve Bank (Fed) and the Bank of England embarked upon huge asset purchasing programs, buying government securities as well as private securities from markets, consequently creating bank reserves on their liabilities side.
This book has provided an overview of how central bank balance sheets function in relation to the real business cycle. In addition, it presents a framework for analyzing the composition of central bank balance sheets. Large variations in the structure of balance sheets are observed across regions and countries. The observed data reveals the evolution of balance sheet compositions since the global financial crisis. Also, the response to the initial crisis in 2007–2009 was similar across a number of economies, whose central banks responded to the crisis by accumulating more foreign assets in order to support financial stability. In contrast, the arrangement of central bank balance sheets has differed significantly from 2009 onward.
In Chapter 1, the book explained the role of central bank balance sheets in designing and understanding the policies needed to support an economic recovery in the post-financial crisis years. It asserts that a deeper comprehension of changes to the central bank balance sheet can lead to more effective policymaking. We support this assertion by highlighting the challenges and controversies faced by central banks in the past and present when implementing policies, and analyze the links between these policies, the central bank balance sheet, and the consequences of these policies at a macroeconomic level.
Chapter 2 presented conceptual definitions involved in gaining a better understanding of the central bank balance sheet size and its composition. Furthermore, it provided a simplified framework to examine the dynamic pattern of central bank balance sheet composition in a conceptual manner. Misconceptions regarding the central bank balance sheet components are explored and discussed in Chapter 3 of the book. However, it must be noted that there are no unified standards that dictate how often a central bank balance sheet should be disclosed to the public, how the sheet should be formatted, or which items are to be included on the balance sheet.
With the empirical data obtained from the International Monetary Fund’s International Financial Statistics and provided by central banks, the book analyzes central bank balance sheet size and composition from 2005 to August 2017 across advanced economies and emerging market economies. The analyses are performed commensurate with Christiaan Pattipeilohy’s (2016) simplified framework.
Interactions between central bank balance sheets and the macroeconomic environment are discussed extensively in Chapter 9. The chapter identifies various measures of computing potential output, and broadly classifies them into two categories: univariate and multivariate. Both linear trend techniques and HP filter techniques are utilized to compute potential gross domestic product.
Questions Left Unanswered: Areas for Future Research
Despite the links established between central bank balance sheets, monetary policy goals, and macroeconomic performance, there is still a need to further understand the underlying causes of differences in balance sheet composition. In addition, the relative weight of both structural and policy-related factors requires more attention from policy makers, academic researchers, and financial sector experts. Other future determinants such as monetary policy strategies (inflation-targeting, exchange-rate targeting), the structure of the financial system (bank- or market-based), and the sources of the legal system (civil or common law) deserve further exploration. It is widely accepted that a reciprocal link is found between the design and operational framework of monetary policy and central bank balance sheets.
Variations in the composition of central bank balance sheets arising from the onset of the global financial crisis lead us to question why some economies are more affected by shocks than others. The asymmetric effects could arise because some central banks have less resilience or expertise to deal with this than other central banks. A deeper understanding of the balance sheet can give policy makers a better idea of how much leeway the central bank has in implementing certain strategies, and could allow policy makers to explore more unconventional monetary responses if the balance sheet has enough slack to allow such strategies without exacerbating negative economic conditions.
As the book empirically reveals substantial differences across central bank balance sheets, especially in the aspect of asset composition, this poses a challenge in attempting to examine the effectiveness of central bank balance sheet policies. Follow-up policy research could investigate to what extent differences in the design of balance sheet policies influence the variations in the macroeconomic and financial effects of balance sheet policies. In addition, policy research that examines the consequences of other types of innovations in the composition of central bank balance sheets would be an interesting field of inquiry.
Policy Debates
As indicated above, the degree to which central banks are exposed to risk significantly relies on the design of the central bank balance sheet, and therefore is contingent upon future balance sheet policies. Central banks in certain economies may be more or less exposed to different types of risk; for instance, exchange risk is attached to foreign exchange holders while credit risk is linked to private sector holders. The need to identify which risks are regarded more or less critical in a certain economy is crucial to avoid implementing misguided and ineffective policies.
The link between monetary policy and other policies is another debate discussed in this book, especially in regard to public debt management. For instance, the holding of government bonds by central banks requires an increased coordination between fiscal and monetary authorities.
The implications of unconventional short-term monetary policies (such as quantitative easing) have been presented in this book. Since programs (such as TARP) that “bail out” financial institutions can be extremely unpopular or politically controversial, it is necessary that monetary authorities closely monitor the use of injected liquidity, plan an exhaustive exit strategy once it has been identified that unconventional policies have achieved their goals, and explore ways to reduce morally hazardous behavior in the future.