NextGen Central Banking: The collateral supply effect on central banking

In March 2020, central banks have once again proven to be the first line of defense in crisis-ridden times. With their far reaching actions they prevented the world from experiencing a collapse of financial markets on top of the severe health and economic crisis caused by Covid-19. Since the global financial crisis, central banks' roles and repertoire have vastly changed. The Federal Reserve has recently adopted a new strategy of average inflation targeting for its monetary policy and the European Central Bank is currently conducting the first strategy review in 17 years - President Lagarde has made it very clear that the ECB intends to address this new role.

Central banks have powerful tools at their disposal. Should they - and if so, how - support policy goals beyond their traditional price stability mandate? The conference “Next Generation Central Banking: Climate change, inequality, financial instability” on 3-5. February 2021 provided a forum on these timely questions.

Sovereign debt is janus-faced: On the one hand, government bonds collect money from investors, sometimes even in foreign currency. On the other, they are an essential part of modern-day financialisation and cross-border lending activity, due to their nature as mostly safe collateral. And it is this very nature of safe collateral that makes for an interesting aspect to be observed by central banks when implementing quantitative easing (QE): Since QE operates by buying government bonds against newly created legal tender, depleting the market of safe collateral can have the perverse effect to contract rather than stimulate lending by the banking sector.

In effect, this calls for some kind of tacit coordination between governments and formally independent central banks in terms of their operations on sovereign debt markets if both are to achieve their intended policy effects.