ECB’s Lane: Central Bank Reserves Should Remain Much Larger Than Pre-GFC
9 November 2023
By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Philip Lane on Thursday said that central bank reserves should ultimately remain considerably larger than they had been up until the crises starting 15 years ago.
In a speech at the ECB Conference on Money Markets, Lane said that ‘the appropriate level of central bank reserves can be expected to remain much higher and be more volatile in this new steady state compared to the relatively low levels that prevailed before the global financial crisis (GFC).’
The GFC, the subsequent sovereign debt crisis and the pandemic more recently had ‘underlined the importance of financial institutions maintaining significant liquidity levels’ so as to ‘avoid the risks associated with excessively-scarce or excessively-abundant reserves’, he argued.
In recognition of currently excessively high liquidity levels, Lane characterised the desirable level of reserves in the eventual steady state as a ‘middle path’ that would balance the advantages and disadvantages of generating reserves whilst making the best possible contribution to banking and financial stability.
The appropriate level of reserves was probably necessary to finance the economy enough for it to get to its ‘steady-state potential output growth rate’, as reserves could be conducive to commercial bank lending ‘in a world much more prone to macro-financial shocks’, he said.
In addition, a central bank would ideally employ different tools to provide reserves, he said. ‘A mix of a structural bond portfolio and longer-term refinancing operations would provide longer-time liquidity to the banking system, while the short-term refinancing operations are well suited to the absorption of higher-frequency liquidity shocks’, he said.
Central banks should be willing to adjust the supply of reserves in response to stress, as a way of limiting steady-state demand for reserves as a precautionary measure, he said.
Similarly, authorities should not exclude the possibility of allowing the central bank balance sheet to balloon again under certain circumstances such as when price stability requires more QE or longer-term refinancing operations, he said.
In other remarks, Lane said that as QT continues, the process ‘can be expected to continue to put upward pressure on term premia and contribute to lower credit creation.’
‘In turn, these contractionary forces lower the projected paths for GDP and inflation and thereby reduce the level of the policy rate required to stabilise inflation at the medium-term target (compared to a counterfactual in which monetary policy tightening was not accompanied by balance sheet reduction)’, he said.