Do Central Banks’ repo Transactions and Liquidity Infusions Increase Financial Stability Risks? A Case for Circular Monetary Economics
- August 9, 2020
- Posted by: RSIS
- Categories: Economics, IJRISS
International Journal of Research and Innovation in Social Science (IJRISS) | Volume IV, Issue VII, July 2020 | ISSN 2454–6186
Henri Kouam
Fellow in Economics, Nkafu Policy Institute
Abstract: Central banks repo market operations and liquidity infusions occasion a structural liquidity mismatch in bank balance sheets and increase the dependence on central bank liquidity. This paper argues for what I term “Circular Monetary Economics”, an approach to monetary policy that seeks to green and prudentially insulate the design and implementation of liquidity and credit facilities. Circular monetary economics will lessen the probability of cross-asset contamination within financial institutions and contagion within the broader financial system, whilst simultaneously improving the transmissions from changes in the policy rate as well as macro-prudential regimes in the event of a climate or credit-driven financial shock.
I. INTRODUCTION
The last decade has seen an approach to monetary policy that has facilitated a financial market dependence on central bank repo facilities and operations in money markets. Admittedly, low and sometimes negative interest rates are justified given weaker transmissions from the labour market to inflation outcomes. Whilst this has occurred at varying intensities amongst advanced economies, the shifting of risk away from the shorter end of the curve via quantitative easing has culminated money market operations and ad-hoc liquidity infusions designed to lessen financial stability risks (Eisenschmidt and Smets, 2018). During and after the financial crisis, permanent open market operations (OMOs) were used to adjust the Federal Reserve’s holdings of securities to put downward pressure on longer-term interest rates and to make financial conditions more accommodative and ensure credit-driven investment and economic growth. Currently, permanent OMOs are used to implement the FOMC’s policies of reinvesting principal payments from its holdings of agency debt and mortgage-backed securities (MBS) and of rolling over maturing Treasury securities at auction (Federal Reserve, 2020). Meanwhile, large scale asset purchases at the European Central Bank (ECB) were also accompanied by targeted longer-term refinancing operations designed to improve the transmissions of monetary policy (ECB, 2020). All these were deigned to improve market functioning and reduce the negative effects of liquidity constraints.
