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ECB’s Liquidity Injections Distort the Economy

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Swiss Finance Institute
Thursday, June 1, 2017 - 08:00

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ECB’s Liquidity Injections Distort the Economy

Mario Draghi famously asserted that the ECB “will do whatever it takes to preserve the euro”. Central banks’ collateral policies—the framework that defines the terms of exchange between central bank money to banks against collateral—and excess liquidity injections have been a central part of this endeavour. For almost nine years now, banks have been able to obtain as much central bank money as they ask for, provided they post sufficient collateral. The result is that the level of excess central bank money in the European banking system now stands at around EUR 1.5 trillion—more than twice the banks’ liquidity needs.

Swiss Finance Institute Professor Kjell G. Nyborg from the University of Zurich reveals in his new book Collateral Frameworks: The Open Secret of Central Banks that these excess liquidity injections helped provide indirect bailouts to banks and sovereigns, absorb collateral from financial markets, and distort the economy. Moreover, central banks favor risky and illiquid collateral which weakens their balance sheet and makes the financial system more vulnerable to systemic shocks and crisis. This raises the question whether central banks have viable exit plans or are large central banks here to stay.Interested to find out more? Read the latest SFI Practitioner Roundup here or register for our free event featuring Mickael Benhaim, Pictet Asset Management; Dr. Andréa M. Maechler, Swiss National Bank; and Prof. Kjell G. Nyborg himself, Swiss Finance Institute & University of Zurich, on 22 June 2017 at Zunfthaus zur Schmiden in Zurich.