The central bank funding stigma
Yesterday the Federal Reserve Bank of New York published a brand new study about the stigma associated with banks borrowing from the central bank’s discount window. That was a nice coincidence following my response to Scott Fullwiler on the MMT and endogenous money theory, which seems to ignore this stigma (or at least to downplay its impact) and to consider that banks freely borrow from the central bank, providing a perfectly elastic high-powered money (reserves) supply. On the contrary, in my view, the stigma is one of the fundamental reasons that undermine the endogenous money theory.
Essentially, the NY Fed does not see much reason for this stigma to exist, but acknowledges that it does exist… I think they entirely forgot the possible impacts on a bank and its stakeholders of being considered illiquid, which I described in my previous post. Nonetheless, they made some good points (see below). A key point in my opinion is that banks are willing to pay more for other sources of funding than use the cheaper discount window.
The four main hypotheses they tested were very US-centric but interesting nonetheless. They found that:
- Banks inside the New York District were 14% less likely to experience the stigma than banks outside of the district (admittedly not that much difference)
- Foreign banks were 28% more likely to experience the stigma than similar US peers
- The largest the financial markets disruption, the higher the stigma
- The stigma does not decline when more banks utilise the discount window
12 responses to “The central bank funding stigma”
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This is an old post, but I have a question nonetheless:
If banks are willing to pay a premium to avoid the stigma of the DW, but DW funding is limitless, then why don’t they borrow ALL their money via the DW?
Ha. I’m not sure I can answer this!
But they simply can’t borrow all their money that way as it would mean having no depositor (as each deposit is a loan to the bank).
Also, competitive pressure may play a role here, to kind of like say “hey guys look, I DON’T need the central bank to run my business”.
This is an interesting topic, but I just want to point out that you might be attacking a strawman. It is sometimes purported that “Horizontalists” argue that banks can lend as much as they want and get the necessary funding afterwards from the discount window. But the majority of the endogenous money folks argues that it is not the DW but the open market operations which fulfill this role. And because the central bank is “forced” to provide as much reserves as needed for the reserve requirement money (deposits and HPM) are endogenous (depending on credit demand and supply).
Even Basil Moore, the foremost proponent of the horizontalists was aware of the stigma of excessive DW borrowing.
But good blog, keep up the good work.
In all papers and blog posts from endogenous money theorists I’ve read so far, none has made the claims you said they have made.
Do you have any particular example of endogenous/MMT paper that mentions the central bank stigma and the use of open market operations?
All the claims I’ve seen so far focused on banks increasing lending on an individual basis and then borrowing the required reserves from the CB. I don’t see how this would work with open market operations as this is a much less ‘precise’ funding operation (an individual bank has little power to influence it) which requires an asset swap. So banks would progressively run out of elligible collateral and hence their liquidity would suffer.