The Size of Central Banks’ Balance Sheets and Financial Stability

Over the last decade, the balance sheet of the Eurosystem has – similarly to other central banks worldwide – increased almost 5-fold as a share of GDP. The fighting of various crises was the trigger and motivation for this expansion. The benefits of avoiding catastrophic outcomes, such a financial and/or sovereign debt crises, were seen to outweigh potential negative side-effects. Now, the Eurosystem – like other central banks – needs to decide whether to reduce its balance sheet to non-crisis levels or to maintain a very large balance sheet in the post-crisis new normal. In a speech from March 2023, Isabel Schnabel, member of the Executive Board of the ECB, discussed the strategic options of the Eurosystem’s future operational framework: she distinguished floor systems (“demand“ or “supply-driven”) and a narrow corridor system. From a financial stability perspective, the key difference between these options is the steady-state size of the ECB’s balance sheet. A supply-driven floor requires a very large central bank balance sheet (relatively close to the current level); a demand-driven floor implies a somewhat smaller one, while a corridor system suggests a substantial reduction of the current balance sheet. In non-crisis times, what would be reasons to maintain a large Eurosystem balance sheet? What financial stability risks might arise from maintaining a very large central bank balance sheet? Would potential benefits of a large central bank balance sheet outweigh the potential cost in terms of financial stability?

This panel brings together renowned researchers who have published on several aspects regarding the interaction between large central bank balance sheets and financial stability.

Program coordination: Ernest Gnan, SUERF, Stefan Kerbl and Stefan Schmitz, Oesterreichische Nationalbank