How Bank of England used its balance sheet in earlier crises? And should it issue shares to fight future crises?

Interesting post by BoE’s Bloggers James Barker, David Bholat and Ryland Thomas.

They point how BoE used its balance sheet in the earlier crises as well:

Although QE often is described as unconventional monetary policy, viewed from a longer-term standpoint, the use of the Bank of England’s balance sheet to implement policy is nothing new. Here we exploit newly released weekly balance sheet data to show how the Bank has previously used its balance sheet to respond to crises. Specifically, we look at the crises of 18471857 and 1866, which have been the subjects of recent Bank Underground posts and are at the heart of a current research project underway at the Bank.

The red lines represent two standard deviations from the average holdings; values between the two lines could be considered “normal”. During the crises (circled), demand for safe assets such as banknotes increased, which, under the provisions of the aforementioned Bank Charter Act of 1844, the Banking Department had to meet out of its note reserve.

In order to supply these extra notes, the Banking Department purchased assets from the private sector (known as discounting of bills) or made loans secured on those assets (known as advances). You can see in the chart below discounts and advances spiking during crises matching the fall in notes and coins in reserve observable in the chart above.

However, if the Bank of England’s note reserve wasn’t enough to meet public demand for money in the crisis, then there was a problem. The 1844 Bank Charter Act meant that the Issue Department was only allowed to print additional notes when they were backed by gold.  During crisis periods, successive governments allowed the Bank to temporarily break this rule so that the Bank could meet the extra demand for notes. This “indemnity” was often enough in itself to reassure markets and end crises; only in 1857 did the Bank actually breach the provisions of the 1844 Act.  This shows the mere potential to use the central bank balance sheet is a powerful instrument in itself.

Hmm..interesting. How the bank buying assets in banking department leads to rise in banknotes in issue department.

They advocate central banks using their equity shares for easing next time:

A second possible development is that central banks start to make more creative use of their equity to implement policy. Typically, central bank equity is seen just as a “loss-absorbing buffer”, instead of being actively used to implement policy. For example QE has worked – roughly speaking – by central banks creating new reserves so they can buy financial assets from the private sector. However, in theory, central banks could achieve the same ends by different bookkeeping means, issuing central bank shares in exchange for private sector assets. These shares would be different from conventional shares in a listed company as they wouldn’t give voting rights on the activities of the central bank, but apart from that, they’d be similar. An upside of using equity to buy private sector assets is that the central bank would be strengthening its capital base at a time when it’s taking on more risk.

This would imply central banks going back to their history. Most started as a private entity whose shares were traded until they were nationalised.

 

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