The Federal Reserve's Balance Sheet as a Financial-Stability Tool

Robin  Greenwood; Samuel Gregory Hanson; Jeremy C. Stein

Article | Jackson Hole Economic Symposium Conference Proceedings (Federal Reserve Bank of Kansas City) | 2016

The Federal Reserve's Balance Sheet as a Financial-Stability Tool

by Robin Greenwood, Samuel Gregory Hanson and Jeremy C. Stein

Abstract

We argue that the Federal Reserve should use its balance sheet to help reduce a key threat to financial stability: the tendency for private-sector financial intermediaries to engage in excessive amounts of maturity transformation—i.e., to finance risky assets using dangerously large volumes of runnable short-term liabilities. Specifically, we make the case that the Fed can complement its regulatory efforts on the financial-stability front by maintaining a relatively large balance sheet, even when policy rates have moved well away from the zero lower bound (ZLB). In so doing, it can help ensure that there is an ample supply of government-provided safe short-term claims—e.g., interest-bearing reserves and reverse repurchase agreements (RRP). By expanding the overall supply of safe short-term claims, the Fed can weaken the market-based incentives for private sector intermediaries to issue too many of their own short-term liabilities. And crucially, we argue that the Fed can crowd out private-sector maturity transformation in this way without compromising the ability of conventional monetary policy to focus on its traditional dual mandate of promoting maximum employment and stable prices.

Keywords: Central Banking; Policy; Risk Management; Public Administration Industry; United States;

Format: Print

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Greenwood, Robin, Samuel Gregory Hanson, and Jeremy C. Stein. "The Federal Reserve's Balance Sheet as a Financial-Stability Tool." Jackson Hole Economic Symposium Conference Proceedings (Federal Reserve Bank of Kansas City) (2016): 335–397. (Internet Appendix Here.)

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The Federal Reserve's Balance Sheet as a Financial-Stability Tool

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