Why Central Banks Should (but Might Not) Keep the Market Flooded With Money
Rate setters are under pressure to ditch the “floor system” they have used to steer monetary policy since the global financial crisis
By Jon Sindreu
Money printing gets a bad rap, but it may be better than the alternative.
In the shadow of today’s big monetary-policy debate about when central banks might cut interest rates lies another crucial question: How should they go about setting rates?
The fact that officials announce a target range or benchmark can obscure the reality that there are many ways of steering the rate at which financial firms lend to each other.
Before the 2008 global financial crisis, officials employed a raft of strategies broadly based on the same idea: At the end of each day, banks overall were short of liquidity and went to borrow so-called reserves at the central bank, which could thus determine at which rate to lend.
Then, in an attempt to stimulate sclerotic economies, central banks started printing trillions of dollars to buy bonds.
This “quantitative easing” flooded the market with reserves, to the point where the banking system didn’t need to borrow any.
The change turned deposit rates into the new benchmarks.
Central banks have facilities that pay banks a return on their idle money—or charge for it if rates are negative, as they were in the eurozone—and it doesn’t make sense for banks to lend below this rate.
The Federal Reserve even extended its overnight deposit service to money-market funds.
With excess money now being mopped up, however, this “floor system” is under threat.
Since 2022, Western central banks have been shrinking their massive balance sheets.
Commercial banks have paid back pandemic loans and bond portfolios have been allowed to mature.
The Fed, the European Central Bank, the Bank of England and the Bank of Canada, among others, have gone further and are actively selling back assets—so-called quantitative tightening or QT.
Some important voices are pushing to accelerate the journey back to the old way of doing things.
Chief among them is Claudio Borio, head of the Monetary and Economic Department of the Bank for International Settlements, a bank for central banks.
“A principle that I personally find attractive is that [a central bank’s] balance sheet should be as small as possible,” he told Dutch central bankers earlier this year.
So far, central bankers themselves seem more cautious.
But they are nonetheless tiptoeing closer to the point where banks may face scarcity of money again.
BOE Executive Director for Markets Andrew Hauser argued last month for continuing to siphon reserves but without going too far.
In a speech in October, the Fed’s manager of the System Open Market Account, Roberto Perli, spoke of transitioning from a system of “abundant” to “ample” reserves, suggesting that a range of indicators can serve to anticipate demand for them.
But this was devilishly difficult to achieve when English economist Arthur Pigou first proposed it in 1917.
It seems likely to be even harder in the post-2008 world, where financial regulations have massively increased liquidity needs.
Today’s rules force banks to hold portfolios of safe, liquid assets and to have extra capital to lend.
Much of their balance-sheet capacity has been absorbed by massive issuances of government debt.
Hedge funds have stepped in to buy the debt too, but they are increasingly using overnight funding.
In a pinch, there are more claims on liquidity than before, and fewer private actors able to provide it.
This makes bouts of monetary scarcity unpredictable.
In 2019, as the Fed was doing QT, the market suddenly flipped back to the pre-2008 normal, leading to spikes in market rates.
There was also volatility last September, as well as earlier this month, as banks struggled to absorb a jump in Treasury supply while complying with balance sheet limits, Risk.net reported.
In this regime, it is still unclear how far rates for borrowing from nonbank sources might differ from the interbank rate targeted by the central bank.
U.S. banks are increasingly having to offer better terms to money-market funds to lure them away from the Fed’s facility and higher-yielding Treasury bills.
Futures markets suggest spreads will widen next year.
In the eurozone, where the financial landscape is more fragmented, the unintended consequences could be greater still.
The appeal of smaller balance sheets may still be hard for central bankers to resist, given the pressure to prove that their money-printing policies are reversible.
Paying banks is politically contentious, which could be one reason why the ECB and the Swiss National Bank decided this year to stop remunerating required reserves.
Central bankers can always regain control of the money market if they need to.
If volatility does emerge in 2024, though, investors will wish another maxim had prevailed over Borio’s: “If it ain’t broke, don’t fix it.”
0 comments:
Publicar un comentario