Jul 1, 2023 - Economy

Central banks are exceptional

Illustration of six central banks in funky colors: European Central Bank, People's Bank of China, Bank of Tanzania, Bank of England, Bank of Brazil and US Federal Reserve.

Illustration: Shoshana Gordon/Axios

Creating central bank reserves doesn't cause inflation. Central bank losses don't matter. And in general, central banks are the exception to most monetary rules.

Why it matters: Central banks are weird and unique animals, with extraordinary — if ill-understood — powers. Those powers are often stymied, however, by people who don't fully comprehend the sui generis nature of central banks.

How it works: Take, for instance, the idea to create some $2 trillion in new SDRs, to be added to the reserves of the world's central banks.

  • Some readers wanted to know: Wouldn't that be inflationary? The answer is no.
  • Rich countries would receive most of the SDRs but wouldn't be able to spend them. As such, those SDRs would just sit in the coffers of places like the Fed or the Bank of England, not being spent. It's spending that causes inflation — demand exceeding supply. But a higher level of reserves at the Fed would not increase the amount of money available to be spent in the real economy.
  • Poor countries would be able to spend their SDRs, mostly by exchanging them into dollars or other hard currencies and buying goods for import. That doesn't cause domestic inflation. Meanwhile, higher domestic spending would amount to only about 0.3% of GDP — nothing remotely inflationary.

Between the lines: Poor countries that can't fund their budget deficits by borrowing in their own currency are at a structural macroeconomic disadvantage. The SDR plan is effectively a way for richer countries to export some of the privilege they've had all along.

What they're saying: "In recent years, the typical central bank has combined the asset growth and asset-liability mismatches of the Silicon Valley Bank with the leverage of Lehman Brothers and the balance-sheet opacity of Enron," writes Edward Chancellor of Breakingviews.

  • That sounds bad — but, in fact, it's a sign of how the rules just don't apply to central banks.
  • The Bank for International Settlements — the institution that understands central banks better than anybody — said earlier this year that "losses and negative equity do not directly affect the ability of central banks to operate effectively."
  • "Whether losses matter for a central bank hinges on understanding the special nature of its finances," wrote the BIS, "including that the usual concept of solvency does not apply."
  • What would be an existential risk for a private-sector institution is little more than an accounting curiosity for a central bank.

Driving the news: Germany's Bundesrechnungshof — the federal audit office — is not convinced and seems to think — contra the finance ministry — that if the Bundesbank loses money, the German government might need to find money in its budget to make the central bank whole.

  • There's no economic need for such a transfer, however. Central banks can lose money indefinitely, especially when those losses come from mark-to-market losses on their bond holdings, without having to borrow that money from anyone.

The bottom line: Central bank balance sheets are an accounting consequence of their monetary-policy activities. They're really not important in and of themselves.

Go deeper: Axios' Neil Irwin, then writing for a U.S. regional newspaper, explained in 2015 what politicians really mean when they say they want to "audit the Fed."

Go deeper