The inflationary consequences of prioritising central bank profits

Stefan Gebauer, Sebastiaan Pool and Julian Schumacher

No 2985, Working Paper Series from European Central Bank

Abstract: This paper examines the impact of rising interest rates on central bank profitability. Using a stylized income model, we demonstrate that changes in interest rates in combination with expansive balance sheet policies introduce a cyclical component into the central bank’s profit and loss statement. Ourfindings reveal, however, that while the interplay of such policies may dampen short-term profitability if interest rates rise, they do not undermine a central bank’s financial strength, because higher interest rates also raise the value of future seigniorage income. Using data for the euro area, we quantify the consequences for inflation of setting interest rates aimed at mitigating financial losses, showing that such a strategy would lead to substantially higher inflation rates. Overall, our findings confirm that a central bank’s willingness to accept temporary losses reflects a commitment to price stability, rather than a hindrance. JEL Classification: E31, E43, E52, E58, E63

Keywords: central bank independence; central bank profitability; monetary policy (search for similar items in EconPapers)
Date: 2024-10
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mon
Note: 2604030
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20242985

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