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Why keeping the balance sheet of the Federal Reserve constant is equivalent to a gradual exit

Gros, Daniel, (2017), “Why keeping the balance sheet of the Federal Reserve constant is equivalent to a gradual exit”, Vox Eu, 12 Ιουνίου

When interest rates are at the zero lower bound, the stance of monetary policy is judged by the size of the balance sheet of the central bank. However, this is not quite correct since one part of the balance sheet is determined by the demand for cash, which has little to do with monetary policy or the state of financial markets. The proper metric for the stance of monetary policy (under the zero lower bound) should thus be excess reserves. Under this metric, the Federal Reserve already started to exit some time ago, and its balance sheet will ‘normalise’ automatically over the next decade, provided the trend of increasing demand for banknotes does not stop.

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