By Viral Acharya, Rahul Chauhan, Raghuram Rajan, Sascha Steffen
The last round of quantitative tightening caused two episodes of significant liquidity stress in US financial markets. This column asks whether the prior expansion and then shrinkage of the Fed’s balance sheet had left the private financial sector more vulnerable to such disruptions. The authors find evidence of ‘liquidity dependency’, whereby the banking system acquires more on- and off-balance-sheet demandable claims during quantitative easing that are not simply reversed with tightening, necessitating even greater central bank balance sheet support in the future. The findings have implications for monetary policy as well as financial stability.
Link: Demandable claims on bank liquidity complicate the unwinding of central bank balance sheets