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Short-term ‘draining’ operations and the nature of reserves

Julian D. A. Wiseman

Abstract: the Bank of England should cease selling 1-week BoE Bills, and, relatedly, should not target the banking sector’s reserves.

Publication history: only here. Usual disclaimer and copyright terms apply.

Contents: Introduction; Short-term ‘draining’ operations; On reserves.

On Thursday 5th March 2009 the Bank published Sterling Monetary Framework; Asset Purchases, announcing various matters relating to the start of ‘Quantitative Easing’. That same day this author wrote a short note commenting on some of the features, good and bad, of the BoE notice. These words expand on that short note.

Short-term ‘draining’ operations

The BoE is engaging in some ‘quantitative easing’, that is, spending money being issued for the purpose, and has announced that it will pay interest, at the policy rate, on reserves balances. Given that, imagine that the BoE is to choose between the following.

The first would lower the measured level of reserves, because balances in the reserve accounts would become balances in a securities account. But otherwise the two courses of action would be functionally equivalent.

But the Bank is doing a version of the former, with 1-week substituting for 1-day. Why? The BoE has not said that it is explicitly targeting reserves, but the decision to sell Bills suggests that the Old Lady is effectively targeting reserves. So, next question: bank-by-bank reserves targeting having been wisely abandoned, what is achieved by targeting, even informally, the system-wide level of reserves?

In summary, the only real effects of the draining operations are bad. Please don’t—and not doing so requires not targeting reserves.

On reserves

There are some very natural measures in finance, that capture the essence of a real something. An example is net worth, particularly for small entities. Net worth is the market price of assets, minus the liabilities discounted at a perfect-credit interest rate. This captures the breakup-and-sale value of the entity. It is the no-messing-around value: it is something with real meaning and import.

Another number that is quoted, most often by central banks, is reserves. Money in a remunerated reserves account is economically identical to a 1-day bill issued by the central bank, but only one of these two counts as reserves. So the system’s reserves can be moved up or down without causing any other economic effect. This very strongly suggests that reserves are not a real thing with real meaning and import, and hence definitely not a sensible thing to target. Please, Old Lady, and other central banks, don’t target reserves, neither formally nor informally; don’t ‘shadow’ reserves, nor do anything else with reserves that can be described by any verb meaning something similar. Reserves are not a natural thing describing something useful, and hence they should not be targeted.

— Julian D. A. Wiseman
New York, 9th March 2009

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