Bigger, broader, faster, stronger? How much should
tomorrow's central bank balance sheets -
do and what
should we leave to financial markets? Some principles for
good parenting
Speech given by
Andrew Hauser, Executive Director, Markets
At the International Finance and Banking Society (IFABS) 2021 Oxford Conference
on "The Financial System(s) of Tomorrow"
Saïd Business School, University of Oxford
13 September 2021
I am grateful to Michael Anson, David Archer, Andrew Bailey, Giulio Bianchi, Sarah Breeden,
Michael Foster, Eddie Gerba, Richard Harrison, Maggie Illingworth, Dennis Jeevarajasingham,
Joshua Jones, Rafael Kinston, Joshua Lillis, Tom Mutton, Shahid Nazir, Arjun Popat, Dave Ramsden,
Andrea Rosen, Joann Spadigam, James Talbot, Catherine Taylor, Anina Thiel and Ryland Thomas
for their comments and assistance in writing this speech.
Introduction
I am delighted to be opening the 2021 IFABS conference. Your subject is
'the financial
of tomorrow' -
system and I want to kick things off by doing some crystal ball gazing at the
role that central banks, as market participants, might play in that future system.
It's actually reassuring
to see in that crystal ball that central banks have a role at all.
Because whenever central bankers get too big for their boots, it's worth
reminding them that,
for most of history, humankind has prospered without them. As late as 1900, there were
the Bank of England's
only 18 central banks globally.1 Just over a century later, speakers at
'peak central bank'.2
2017 inflation targeting conference predicted the passing of And the
-
favourite pastime in cryptocurrency circles is to imagine a world immeasurably superior in
-
their view in which the rulebooks, committees and hallways of Frankfurt, Washington,
Tokyo and London have been replaced with a few tightly-coded algorithms floating in
cyberspace.
Yet as of autumn 2021, central banks dominate financial market discourse as never before.
There's
been particular focus on the sharp increase in the size of central bank balance
sheets, most recently as the result of the extraordinary steps required to respond to the
economic impact of Covid. In due course, those balance sheets will start to shrink again as
tide recedes, what's left will not be what we knew
the recovery takes hold. But as that 10-20
And that's
years ago. because fundamental shifts in economic and financial structures
mean that central bank balance sheets are also set to play a much broader role in the future.
Helping to meet the heightened demand for safe assets in financial markets. Playing a more
active, countercyclical part in monetary policy setting. And potentially providing new retail
payment media, in the form of Central Bank Digital Currencies.
Central banks can't choose whether to take the actions necessary to deliver their monetary
and financial stability mandates: they are obligated to do so. But they do have choices
-
about how they go about it and a key factor in those judgments is the role they want
financial markets to play. In my remarks today, I want to do three things. First, to show just
how dramatically the role of central bank balance sheets has changed in recent years, and
the forces shaping the future. Second, to review the complex and shifting inter-relationships
between central banks and financial markets over history. And, third, to suggest some
possible principles for shaping central bank operations of the future in ways that harness the
benefits of financial markets.
Bigger, broader, faster, stronger? The central bank of today (and tomorrow)
The scale of central bank balance sheet growth has certainly been extraordinary. The
-
Bank of England, for example, now has assets of nearly £1 trillion equivalent to almost half
the annual output of the UK economy. That ratio is 10 times what it was in 2006, and more
-
than double any previous peak in our 327 year history including the wars of the 18th and
20th centuries (Chart 1).
And we're not alone:
other central banks have seen similar increases (Chart 2).
Bigger: in the UK...
Chart 1: Chart 2: ...and overseas
Sources: Bank of England, Office for National Statistics.
Individual central banks' published data,
Sources: IMF.
'Quantitative Easing
So-called (QE)' has of course been a key driver of this increase in many
countries, including the UK. But while balance sheet size may have grabbed the headlines,
arguably the more important trend in recent years has been the broadening scope or breadth
of uses to which central bank balance sheets have been put.
That shift was particularly vividly on display during the early stages of the Covid crisis, when
central banks reached for an unparalleled variety of policy tools, ranging from standard
interest rate and liquidity operations or asset purchases, to term lending, foreign currency
and targeted credit support operations (Chart 3). Many of those Covid-specific interventions
unwind. The UK's Covid Corporate Financing
have already begun to Facility, for example,
closed to new lending in March 2021, and will liquidate completely early next year. The
scale and frequency of operations backed by the dollar and euro swaplines have been
scaled back. And QE will start to run off too, when policy makers judge it to be warranted by
the outlook for inflation and activity.3
Chart 3: Broader: during Covid... Chart 4: ...but over the longer run too
Balance sheet measures taken by Financial
Stability Board (FSB) members during Covid
% of FSB AE/EME
members
Source: Bank estimates based on published material by
individual central banks and the Bank for International
Settlements.
Source: "A global shock to a global system: Covid-19 and
regulatory framework" by Dietrich Domanski,
the post-2008
Note: chart shows balance sheet tools developed/operated
in: Monetary Policy and Central Banking in the Covid Era |
during each period including: short duration / term lending;
VOX, CEPR Policy Portal (voxeu.org)
asset purchases; and FX tools including swap lines (USD
repo swap lines with the Federal Reserve Bank of New York
counted as one tool; additional swaplines captured
collectively as one additional tool for each central bank).
But the broadening in the scope of central bank balance sheet activities has been under way
for longer, and goes much deeper, than the temporary response to the extreme
Bank of England's
circumstances of Covid alone. The balance sheet toolkit, for example,
-
has more than quadrupled in size since the early 2000s a trend evident at other major
central banks too (Chart 4).
This broadening, and its likely further extension in the years to come, reflects three main
structural drivers.
First, changes to regulation and market structure since the Global Financial Crisis (GFC) of
2008-9, amplified by a greater recognition of the importance of financial stability, mean
financial market participants have a much higher structural demand for High Quality Liquid
Assets (HQLA) to meet potential outflows. Central bank reserves are not the only form of
-
HQLA government debt also qualifies, for example. But reserves are clearly the most
liquid. It is hard to estimate banks' future structural demand for these reserves with any
precision, not least because it will depend on the relative rates of return available on other
forms of HQLA. But an exercise conducted by the Bank put UK banks' aggregate 'Preferred
of Reserves' (PMRR)
Minimum Range at some £150-250bn (c15% GDP) in 2019.4 For
comparison, reserves in 2006-7 were of the order of £20bn.
Non-bank financial intermediaries (NBFIs) have historically relied on banks and government
assets for liquidity. But a key lesson of the 'dash for cash' in March 2020 was that
the
liquidity of both could dry up in a sufficiently severe stress, triggering asset fire sales and
amplifying instability. Primary responsibility for ensuring they are resilient to such shocks
lies with NBFIs themselves, enforced through appropriate regulation and supervision.5 But
-
self insurance cannot cover every threat to stability so central banks that want to avoid
having to use monetary policy tools like QE again may have to develop more targeted
backstops against future market dysfunction, providing liquidity to a wider set of market
participants that meet appropriate regulatory safeguards.6
A consequence of these trends is that there will be some level of reserves supply, varying
over time and states of the world, but materially higher than in the pre-GFC period, below
which central banks cannot go without driving short-term market rates up above policy
target the Bank of England's
makers' levels. Today, the size of balance sheet is set by the
level of QE assets required to set monetary policy. As QE unwinds, that role will shift to the
system's desired demand for reserves. QE unwind does
not need to stop when reserves hit
-
that level but we will need to replace long-duration QE assets with shorter term repos or
other Open Market Operations to maintain the size of the balance sheet (Chart 5).
The second driver of structurally higher central bank balance sheets relates to trends in
global interest rates. Monetary policy works through nominal interest rates, with the goal of
pushing real interest rates up or down relative to their long-run sustainable level, known as
the 'equilibrium real rate' or 'r*'. r* itself is driven, not by central bank policy, but by
fundamental global economic factors, such as desired savings and investment flows and
technological progress. Estimates of trend r* have fallen significantly in recent decades
(Chart 6 illustrates this for the US). That would not constrain policy if nominal interest rates
could go negative to an unlimited degree. But in practice that is not possible: they are
subject to an 'Effective Lower Bound (ELB)'.
Chart 5: Stylised Bank of England balance Chart 6: Estimates of the US
sheet as QE exit proceeds equilibrium real interest rate
Sources: Bloomberg Finance L.P., Federal Reserve
Bank of New York, June 2021 Summary of Economic
Projections Federal Open Market Committee and Bank
calculations.
Notes: R* is the trend value of r*. Implied range derived
FOMC members' published
from projections for long run
Fed Funds rate and inflation.
To the extent that r* remains low in the future - and few expect a rapid rebound - central
banks will have to become used to operating much more frequently at or around the ELB. In
some cases, central banks may be able to lower the ELB somewhat through the
development of negative interest rate tools. Policy rates in the euro area, Switzerland and
-
Japan have been negative for some time and the Bank of England recently confirmed that
practical preparations to implement a negative Bank Rate were in place, should the MPC
judge that necessary.7 But, at best, official rates can go only modestly negative. So a lower
r* is also likely to mean more active use of the central bank balance sheet to implement
today's
monetary policy. That does not mean that QE will never unwind: indeed, quite the
Bank's
reverse, unwind will become an integral part of future tightening strategies, as the
August 2021 Monetary Policy Report sets out. But it does suggest the balance sheet will
expand and contract more regularly, on a counter-cyclical basis, than it has in the past.8
Chart 7: Central bank R&D on CBDCs Chart 8: Adding it all together: a highly
stylised picture of the central bank balance
sheet of tomorrow
Source: BIS Annual Economic Report 2021
A third, very different, trend shaping the outlook for central bank balance sheets is the
potential development of Central Bank Digital Currencies, or 'CBDCs'. Research work in this
area has exploded recently (Chart 7), as the debate about the need for an unquestionably
safe state-backed retail digital payments medium for online transactions has intensified.9 No
decision has yet been made as to whether to introduce a sterling CBDC, or what form it
-
might take and the technological development work required would take some years to
complete. But the implications for the size of the Bank's balance sheet could be significant:
illustrative scenario in the Bank's June Discussion
an Paper, for example, considered a
world in which a fifth of household and corporate deposits, worth upwards of £400bn10,
transferred to a new digital currency.
Combining these three drivers together allows us to draw a stylised picture of the central
bank balance sheet of tomorrow (Chart 8): (a) structurally larger than it was pre-GFC, even
-
after the unwind of the current QE programme reflecting the higher demand for reserves,
and the possible provision of a CBDC; but (b) more variable too, as the balance sheet plays
a more active countercyclical role in monetary policy and liquidity provision.
How big should central bank balance sheets be? Some conceptual considerations
drivers I've
Now this is all very interesting, you may say, but so what? Each of the
central banks'
mentioned lies squarely in core mandate. So long as central banks are
achieving those goals, why should their size have any implications over and above that?
There is certainly a respectable view that central banks should be relaxed about the growing
size of their domestic-currency liabilities (reserves, banknotes or any future CBDC).11 Such
liabilities can be created at near-zero cost, and provide a social good by making the system
safer. Any tendency for higher reserves supply to push market interest rates below policy
makers' targets, imperilling 'floor'
inflation goals, can be avoided through the use of so-called
monetary control frameworks. And the potential for higher reserves to expand bank balance
sheets beyond regulatory leverage limits, crowding out credit supply, can be fixed by
exempting reserves from the calculation. Both mechanisms are in place in the UK.12
Those who do worry about central bank size tend to focus more on the asset side of the
balance sheet, and the tools that underpin them, citing one or more of the following as
potential costs:
- The first is a concern about the potential risks to public money if central banks
hold large stocks of assets bearing market or credit risk. These risks are greatest for
holdings of private sector assets (central bank purchases of government assets
involve no increase in the gross exposure of the public sector as a whole);
- The second relates to concerns that, beyond some threshold, the scale or nature of a
central bank's asset holdings might expose it to
heightened risk of political
interference, compromising its ability to deliver its core mandate. To this is
sometimes added a worry that the optics of remunerating banks on large stocks of
reserves may be problematic (though the merits of this view are unclear since such
payments usually involve no net resource transfer from the public sector);
- The third relates straightforwardly to organisational efficiency: the larger and
broader a central bank's operations, the greater the resource cost
of developing,
operating and risk managing its balance sheet, and communicating and resolving
overlaps and tradeoffs between its tools; and
- The fourth relates to the potential implications for the functioning of financial
markets.
Careful scrutiny and analysis of these potential costs has been a relatively under-researched
area recently, and it would be great to hear more from IFABS members and others on this
important issue in coming years. But I want to focus my remarks today on the last item in
the list: the potential implications for financial market functioning.
A short history of central banks and financial markets: family, friends or foes?
Central banks have a close relationship with financial markets and the firms that participate
in them. We rely on them, directly, to transmit policy to the wider economy; and, indirectly,
- -
to channel savings into investment, price and manage risk, provide and innovate new
services to households and firms. But that reliance means we also need to be ready to
intervene to ensure markets function safely and effectively. We do that by: setting
appropriate safeguards as micro- and macro-prudential regulators; providing liquidity, and
'peace time' and stress; and, on occasion,
other interventions, in both using our central
position to encourage or co-ordinate stability-enhancing innovation.
But the relationship runs even deeper than this. Central banks and markets are not merely
distinct entities that interact transactionally. The actions of each are fundamental to shaping
the other's future development - -
their structures, strategies and investment programmes
which then feed back in turn. One important consequence of this is that even temporary
changes, on either side, can have profound and lasting effects.
Academics sometimes compare this complex path dependency to that seen in biological
systems. Clemens Jobst and Stefano Ugolini, for example, described it as a process of
And Andy Haldane compared the financial sector as a whole to a 'complex
'co-evolution'.13
system'.14
adaptive But I want to frame my remarks today around a slightly more purposive
analogy: that of parenting. According to the Maccoby and Martin model, summarised in
-
Table 1, parental styles can be differentiated into four main types 'neglectful', 'indulgent',
-
'authoritarian' or 'authoritative' depending on the degree of affection felt by the parent to
the child, and the degree of control exerted.
Table 1: Maccoby and Martin's Four Parenting Styles15
Control
Low High
Low Neglectful Authoritarian
Affection
Indulgent Authoritative
High
might be thought that the 'parent'
It in this setup would typically be the central bank.16 But
relations can in fact run both ways. Indeed, many central banks grew out of the market as
quasi-commercial undertakings, albeit with special note issuing rights granted by
18
governments needy for (often war-related) finance.17 To say that these young upstarts
were unwelcome offspring would be putting it mildly. The Bank of England, for example,
was assailed from all sides following its birth in 1694. Banker Richard Hoare accused the
Bank of being poised to 'engross most of
the ready money in and near the City of London.'
And an anonymous pamphleteer said the Bank risked giving 'a mighty damp to commerce ...
by cutting off, at one blow, all personal securities', whilst arguing that 'extract[ing] profits ...
not the Publick one jot'.19
from one another enriches
15
Handbook of
Maccoby E. Martin J. Socialization in the context of the family: Parent-child interaction. In: Mussen PH, editor.
Child Psychology. Wiley; New York: 1983. pp. 1-101.
16
Public commentary has a tendency to see things this way! See eg How Much Do Central Banks Fear the Bond Toddler? -
Bloomberg
17
This section draws heavily on historical analysis by Charles Goodhart, set out in numerous papers including: "The business
1972; "What do central banks do?", 1989; and "The changing role of central banks", 2010.
of banking: 1891-1914",
18
As this discussion immediately reveals, the bipartite relationship between central banks and markets is of course really a
tripartite one, involving governments too. The extra complexities of that three-way interaction are however too multi-faceted to
cover in this speech!
19
See David Kynaston, "A history of the Bank of England 1694-2013" and Angliae tutamen, or, The safety of England being an
account of the banks, lotteries, mines, diving, draining, lifting, and other engines, and many pernicious projects now on foot
tending to the destruction of trade and commerce, and the impoverishing this realm : with reflections thereon of great import to
"...for,
all sorts of people / by a person of honour. (umich.edu). The pamphlet is not universally critical of the Bank however:
besides what have been already mention'd, it has almost crush'd several sorts of Blood-suckers, mere Vermin, Usurers and
Gripers, Goldsmiths, Tally-Jobbers, Exchequer-Brokers, and Knavish Money-Scriveners, and Pawn-Brokers, with their Twenty
and Thirty per Cent. at their Girdles, Procurations and Continuations, and the rest of that Fardel."
The battle over how best to constrain the Bank's commercial
activities raged for more than a
century. Progressively more binding convertibility requirements were applied, first to its
issuance of banknotes (via the 1844 Bank of England Act) and later to its broader activities,
as it became clear that the Bank could not credibly continue to compete with private markets
it was simultaneously seeking to oversee. But old habits died hard. As late as 1910, it took
a threat from the London clearing banks that they would establish a rival central bank to get
the Bank to agree to run down its remaining commercial business.
While central banks outgrew these teenage tendencies and began acting more clearly as
parents in the twentieth century, their role continued to co-evolve closely with that of financial
markets:

The period from the Great Depression in the 1930s to the 1960s/70s saw central
'authoritarian'
banks acting as parents, reflecting low affection for the market, and a
high desire for control. A panoply of macroeconomic, regulatory and market-facing
interventions aimed to shape and channel markets to social ends.

Just as authoritarian parenting is often the architect of its own downfall, the efficacy
of these controls was ultimately undermined by a rebellion on the part of the markets.
The development of eurobonds, largely outside the controls erected by central banks,
undermined constraints on credit creation and the Bretton Woods regime of fixed
exchange rates. That collapse in authority, amplified with a broader concern about
'indulgent' parenting regime -
'government failure', led ultimately to the of the 1980s
in which high affection for the market led to a stripping away of controls. Central
bank balance sheets during this period hit a cyclical low (Chart 1), and inflation
targeting became the dominant monetary regime.

The indulgent phase ended in 2008-9, with the GFC. Whilst inflation targeting
continued on the monetary policy side, the subsequent 15 years saw a return to a
desire for greater control over market forces, reflected in new global and national
frameworks for microprudential, macroprudential and conduct regulation.
Greater control returns us to the right hand column of the model in Table 1. The question
-
then is whether we aspire to be 'authoritarian' or 'authoritative' which depends on our
attitude to financial markets. And here we face a conflict. Households and firms rely on
financial markets like never before - so we need them to thrive. But we also need them to
be safe: we cannot risk exposing economies again to the sorts of volatility and cost
experienced in 2008-09, or those that could have occurred in 2020 had the policy response
not been swift and decisive. And we need to continue to achieve our monetary policy goals.
The tools used to deliver these outcomes are very different from those used in past periods.
But the balance between central banks and markets has still turned. Judged on size alone,
balance sheet as a share of the UK financial sector has returned to
the Bank of England's
- the height of the 'authoritarian' period
levels last seen in the 1960s/70s (Chart 9). Central
banks hold a significant share of their respective government bond markets (Chart 10). And
our liquidity-provision toolkit is substantially more comprehensive than ever before.
Chart 9: Bank of England balance sheet Chart 10: Share of national government
as a proportion of UK financial sector debt held by central banks
Source: Bloomberg Finance L.P., Bank of England, Bank
Sources: public data from central banks, debt management
calculations.
agencies and fiscal authorities.
authoritative: some good parenting principles for tomorrow's central bank
How to be
What does all of this mean for tomorrow's central bank balance sheets?
It cannot mean pulling back from taking the necessary steps to deliver our mandates in a
changing world, of lower sustainable interest rates, structural change in wholesale and retail
markets, and the need to maintain financial stability. Those are non-negotiable.
But history does I think suggest three broad principles to help inform how we design our
interventions, in ways that help markets continue functioning and thriving safely, in the
service of the wider economy. I want to illustrate each principle with some observations on
current market functioning and the design of future central bank tools.
Reflecting on the tendency for markets to adjust endogenously in ways that can induce
hysteresis and path dependency, the first principle is that central banks should gather
regular and detailed intelligence on how market structures are evolving in response to
the use of balance sheet tools.
Central banks have long monitored the impact of their policies on core market prices and
other variables observable day-to-day. But we also need to understand where participants
in the broader markets supporting household and firms are committing their capital, where
they are putting their most talented people, where they are spending their IT investment
budgets, and how they manage and trade risk. Key questions in the current conjuncture
include: the commitment of capital to making markets in core assets vs investment in
capital-light matching technologies; the allocation of expert risk pricers and managers across
more and less liquid markets; the extent to which investor relationships are being maintained
in less heavily traded sectors; and the incidence of leverage, particularly outside the
regulated sector.
The history I just reviewed suggested that central banks can exert a dead hand on market
functioning where interventions are poorly designed, depressing social welfare and
ultimately causing markets to evolve in ways that undermine the original policy intent. A
second principle is therefore that the burden of proof should lie squarely with those
arguing for a new central bank intervention to explain why financial markets cannot
'Do only what only you can do'.
do it better.
-
The key interventions of recent years clearly pass this test. Markets cannot issue reserves
so they cannot implement monetary policy, get round the lower bound to nominal interest
-
rates or act as lenders, or buyers, of last resort. At the same time, central banks will never
have the breadth and depth of knowledge required to price the huge majority of firm-,
country- and scenario-specific risks that markets specialise in. And they are unlikely to be
anything like as effective in bringing together borrowers and lenders, or developing
innovative products to meet their needs. To the greatest possible extent, we need financial
markets to be focused on these fundamental aspects of their job, not spending all their time
next
trying to predict central banks' moves.
Two current examples help bring this principle to life:
- First, meeting the demand for reserves as a safe asset is a core central banking
activity, as I discussed earlier. But there is no need to provide more reserves than
the system wishes to hold, once QE unwinds. That's why we expect to adopt a
market-led approach, in which we allow reserves to fall as QE assets roll off, but
stand ready to replace any demand shortfall that might arise through shorter term
This should allow us to run a 'lean' balance sheet -
open market operations. giving
-
markets scope to function without suffering excessive upward pressure on
short-term rates.20
-
Second, as we turn to consider the potential design of CBDC, there will be important
decisions to take on whether to remunerate the instrument, whether to limit access to
in some way, and how much functionality to provide in addition to its basic role as a
retail payment medium. Different combinations of these characteristics will
determine the likely level of demand, the impact on our balance sheet, and the extent
to which CBDC competes directly with private deposits: running on a spectrum from
relatively low (for a low-function, unremunerated, limited-access model) to potentially
substantial (for a high-function, remunerated, unlimited-access model).
The third principle comes straight from the playbook of authoritative parenting: where
central banks decide their mandates require them to intervene, they should (i) set
clear ex ante expectations of the conditions for intervention; (ii) minimise predictable
adverse effects; and (iii) set clear exit strategies.
ex ante
A good example of the need for setting clear expectations comes in the area of
potential future liquidity tools for market dysfunction. Some market participants may have
concluded from the exceptional response of Spring 2020 that central banks would respond
to future dysfunction in equal speed and size. But it is not clear that is the case. Any future
targeted standing facilities are likely to make it clear that markets should not expect central
banks to respond as aggressively to dysfunction unrelated to a global pandemic, and market
participants should therefore build stronger self insurance, and expect greater regulatory
scrutiny, in exchange for central bank access.
In common with most other central banks, the Bank of England has taken a number of steps
to reduce some of the most severe adverse effects of its QE programme. These include
limits on the proportion of any individual gilt that we can own, a gilt lending programme to
relieve specific collateral shortages, and clear and transparent auction procedures.21
Finally, a credible exit strategy can help maintain market functioning, encouraging
participants to maintain resourcing and counterparty relationships in expectation that key
The Bank's Monetary Policy Committee recently set out a
markets will come back onstream.
new QE exit strategy, bringing forward the level of Bank Rate at which it would begin
reducing its holdings of government bonds to 0.5%.22 Clear conditions for exit can also help
manage the potential adverse incentive effects of liquidity insurance tools.
Conclusions
Let me conclude.
The central bank balance sheets of the future will be very different to those we knew at the
start of the millennium.
-
They will be structurally larger, even after current QE programmes unwind as central
banks meet a bigger share of the structurally higher demand for liquidity; and contemplate
possible Central Bank Digital Currencies.
-
And they will be more variable as lower global interest rates and a broader liquidity
insurance toolkit mean balance sheets play a more active countercyclical role.
Central banks cannot shirk their responsibilities to maintain monetary and financial stability.
- and I've
But they do have choices about how to do so suggested three principles to help
ensure they do so in ways that help markets function well and safely, in the service of the
wider economy. By gathering regular and detailed intelligence on market structures. By
placing the burden of proof on explaining why financial markets cannot do it better. And,
where intervention is needed, by setting clear ex ante expectations, minimising predictable
adverse effects, and developing clear exit strategies.
There is a huge opportunity for the research community to help central banks plot a future
path in this area. Many of the issues I've discussed today have received only limited
academic attention in recent years. It would be great if IFABS and its wide membership can
help turn that tide. I look forward to that conversation.