Liquidity Dependence and the Waxing and Waning of Central Bank Balance Sheets

Viral Acharya, Rahul Chauhan, Raghuram Rajan and Sascha Steffen

No 17622, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: When the Federal Reserve (Fed) expanded its balance sheet via quantitative easing (QE), commercial banks typically financed reserve holdings with uninsured demandable deposits. They also issued credit lines to corporations. In the aggregate, these bank-issued claims on liquidity did not shrink commensurately when the Fed halted QE and turned to quantitative tightening (QT). Consequently, banks that increased liquidity risk exposure – especially small and regional banks – became vulnerable to liquidity shocks, necessitating further liquidity provision by the Fed. The evidence suggests that the expansion and shrinkage of central bank balance sheets has led to liquidity dependence of banks on central banks.

Keywords: Monetary policy; Federal Reserve; Quantitative easing; Financial stability; Deposits; Financial fragility; Large-scale asset purchases; Quantitative tightening; Fed normalization; Lines of credit (search for similar items in EconPapers)
JEL-codes: E5 G01 G2 (search for similar items in EconPapers)
Date: 2022-10
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Working Paper: Liquidity Dependence and the Waxing and Waning of Central Bank Balance Sheets (2023)
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