Anchoring QT: Liquidity, credit and monetary policy implementation

Carlo Altavilla, Massimo Rostagno and Julian Schumacher

No 18581, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Central banks aim for a policy of shrinking their balance sheets (QT) that is as neutral as possible to the setting of their policy rate. But the identification of a neutral path for QT hinges upon the choice of an operating framework for implementing monetary policy in steady state. The framework determines whether banks’ liquid reserves are ample or scarce, and this uniquely pins down the size of the central bank balance sheet in the long run. We focus on the euro area and identify a baseline path that embodies current expectations – our neutrality yardstick – and simulate paths that converge to two polar forms of implementation frameworks: a floor system and a ceiling system. In the former, the central bank deliberately creates a large amount of non-borrowed reserves. In the latter, banks borrow as much as they need from the central bank. Using bank-level and loan-by-loan data, we find an empirically robust positive connection between non-borrowed reserves and loans, whereas no such connection exists between loans and borrowed reserves. By our neutrality score, the floor option outperforms the ceiling option as it generates a more moderate loan contraction relative to baseline. But the baseline convergence to a quantity of non-borrowed reserves consistent with the Friedman rule – just saturating the system – is preferable. We conclude that a neutral QT should run at the expected pace until mid-2026. Then, the balance sheet should start growing again to finance the secular growth in the demand for central bank liabilities.

Keywords: Quantitative tightening; Monetary policy implementation (search for similar items in EconPapers)
JEL-codes: E43 E5 G2 (search for similar items in EconPapers)
Date: 2023-11
References: Add references at CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP18581 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:18581

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP18581

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().