BIS 87th Annual Report, 2016/17

The BIS 87th Annual Report, 2016/17 was just released. As we might expect, it implicitly provides some criticism of monetary policy over the previous years. Claudio Borio, the BIS’s Head of the Monetary and Economic Department, concludes “The end may come to resemble more closely a financial boom gone wrong, just as the latest recession showed, with a vengeance”. The BIS has shown strong Austrian tendencies and has even cited Hayek and Mises in several papers over the last few years. They have also cited Knut Wicksell who influenced the Austrian School with his notion of the natural rate of interest.


There are some other interesting points such as the nature of the composition of asset holdings of central banks, for instance:


The composition of the assets held in the portfolio adds another set of considerations. One dimension concerns the maturity structure. The longer the maturity, the longer the period needed for the unwinding. The average residual maturity of central banks’ holdings of government securities varies widely, ranging from five years in Sweden to 12 years in the United Kingdom (Table IV.1). Another dimension is the distinction between private and public sector claims. In the case of the Federal Reserve, for instance, it currently holds around $1.5 trillion of mortgage-backed securities that will mature between 2040 and 2048. Historically, claims on the private sector have only made up a small fraction of the Federal Reserve’s balance sheet. In the case of the Eurosystem, market liquidity issues in some national sovereign and corporate markets could be especially important, given the large share of central bank holdings.


There is also a great analysis of the effects of monetary normalisation on the fiscal situation for some economies – unfortunately, as we all know, many countries have used the loose monetary policy years to behave like wastrels rather than get to grips with their debt problem while they have the chance:


While much attention has focused on the impact on bond yields of changes in central banks’ large-scale government bond purchases, the effect on a government’s financing costs has gone largely unremarked. And yet, if those changes are large enough, the impact can be sizeable. And this could have significant macroeconomic implications especially in economies with a high government debt-to-GDP ratio.

The main reason is simple. From a consolidated public sector balance sheet perspective (ie one that nets out assets and liabilities between the central bank and government), large-scale purchases amount to a withdrawal of duration from the market: it is as if the government replaces long-term debt – the amount purchased by the central bank – with very short-term debt – the liabilities the central bank issues to finance the purchases.icon Since these liabilities typically take the form of excess reserves held by banks, they are equivalent to overnight-indexed debt.icon This makes the government’s net borrowing costs more sensitive to higher rates.

How large can this effect be? A back-of-the-envelope calculation can help put this in context. Assume, for simplicity, that at the time of a policy rate increase all government bonds held by the central bank have a residual maturity of at least two years (ie none of the securities mature within that period) and that the central bank does not purchase any new securities.icon Assume further that those bonds were issued at a fixed interest rate. This means that an increase in the cost of remunerating excess reserves (which moves with the policy rate) will not be matched by any increase in interest on central bank bond holdings. If the excess reserves in this calculation are, say, 10% of total government debt outstanding, each 1% increase in rates would raise interest payments by 0.1% of the debt stock.

The impact can be particularly significant when excess reserves and government debt are large. For instance, if central bank excess reserves are 50% of outstanding government debt, a 200 basis point rate rise would amount to 1% of government debt. If interest payments on government debt are, on average, 2%, this would be equivalent to a 50% increase in debt financing costs. And if the debt-to-GDP ratio were 100%, this would translate one-to-one into percentage points of GDP.


You can see the full report here: