16 02 2015
The central banks and their bottom line
From the Swiss National Bank to the Federal Reserve and the ECB, concerns are mounting over central bank liabilities. But should we really be worried?
Around the world, central banks’ balance sheets are becoming an increasingly serious concern – most notably for monetary policymakers themselves. When the Swiss National Bank (SNB) abandoned its exchange-rate peg last month, causing the franc to soar by a nosebleed-inducing 20%, it seemed to be acting out of fear that it would suffer balance-sheet losses if it kept purchasing euros and other foreign currencies.
Similarly, critics of the decision to embark on quantitative easing in the eurozone worry that the European Central Bank is dangerously exposed to losses on the southern eurozone members’ government bonds. This prompted the ECB Council to leave 80% of those bond purchases on the balance sheets of national central banks, where they will be the responsibility of national governments.
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In the United States, meanwhile, the “Audit the Fed” movement is back. Motivated by growth in the Federal Reserve’s assets and liabilities, Republicans are introducing bills in both chambers of Congress to require the Fed to reveal more information about its monetary and financial operations.
But should central banks really worry so much about balance-sheet profits and losses? The answer, to put it bluntly, is no.
To be sure, central bankers, like other bankers, do not like losses. But central banks are not like other banks. They are not profit-oriented businesses. Rather, they are agencies for pursuing the public good. Their first responsibility is hitting their inflation target. Their second responsibility is to help close the output gap. Their third responsibility is to ensure financial stability. Balance-sheet considerations rank, at best, a distant fourth on the list of worthy monetary-policy goals.
Equally important, central banks have limited tools with which to pursue these objectives. It follows that a consideration that ranks only fourth in terms of priorities should not be allowed to dictate policy.
Indeed, a clear understanding of their priorities has often led central banks to incur losses when doing so is the price of avoiding deflation or preventing the exchange rate from becoming dangerously overvalued. The Chilean, Czech, and Israeli central banks, for example, have operated with negative net capital for extended periods without damaging their policies.
The reason why adverse consequences need not follow is that the central bank can simply ask the government to replenish its capital, much like when a government covers the losses of its national post office. Everyone is happier when transfers flow the other way. But the role of the central bank is not to be a profit centre, especially when those profits come at the cost of other, more important policy objectives.