Printer Go Brrr: The Evolution of Central Banks Balance Sheets

Research
• Mar 29, 2023
Printer Go Brrr: The Evolution of Central Banks Balance Sheets

by Ryan Shea

Key Take-aways

  • Printer Go Brrr is a popular crypto meme. Amusing as it is, if this is an investment narrative people are buying into when they buy crypto it’s worth clarifying what it actually entails, because it is not as straightforward as many people think.
  • Central banks typically inject money into the banking system via purchases of financial assets – primarily government bonds. During the Great Recession these purchases where aggressively ramped up, fuelling fears of inflation
  • Such fears were exaggerated because of a fundamental misunderstanding about how money is created in a world where it is predominantly held and used in electronic form.
  • Surprised by the lack of inflation in the post Great Recession period, the myth that policymakers are impotent was born. However, the surge in inflation after the Covid Pandemic shows how false this perception was.
  • Inflation, it turns out, is a policy choice. Critically though, it is determined by the interaction of fiscal and monetary policy. Printer Go Burr is only half of the story.

I was recently called out on Twitter for using loaded language. What was the loaded language I used? “[M]oney printing” and “the printing press”, both which I used in reference to central banks. Now we are talking about Twitter here not the American Economic Review, so hardly a cardinal sin, but the pushback got me thinking. Printer Go Brrr, as many people familiar with crypto know, is a popular meme. Amusing as memes are, if this is an investment narrative people are buying into when they buy crypto it’s worth clarifying what “Printer Go Brrr” actually entails, especially given the tremendous rally crypto prices have experienced in tandem with escalating turmoil in the tradfi banking sector, because it is not as straightforward as I suspect many people think.

In the olden days – and I mean long before 1990, which is when my kids think the olden days begin – money primarily took the form of bank notes and coins. If a central bank, for example, wanted to add to the money supply it could fire up “the printing press”, stuff in paper at one end and have newly created bank notes come out the other end, money that could be distributed to the general public either directly or via commercial banks.

Obviously, simply printing and distributing bank notes to the public (in modern economies central banks are passive issuers of bank notes, responding to changes in demand by the public at ATMs and bank counters1) is not a great business model. Who would want to own such money? Very few people because one of the three prerequisite functions of money is it needs to serve as a store of value. As shown by the following image taken from a Bank of England paper2, bank notes constitute a liability for the central bank. To be worth something ie, to have some value to store, there needs to be a corresponding asset on the the other side of the ledger3.

Stylized Central Bank Balance Sheet

Printer Go Brrr: The Evolution of Central Banks Balance Sheets

Source: Bank of England

Once Upon A Time

One of the first central banks to be founded was the BoE (the Swedish Riksbank – founded in 1668 - beat them by a couple of decades). In the early days its balance sheet was pretty simple. In 1696 (yes you read that right – it’s not a typo4) it had total assets of £3.2mn, comprising of £2.8mn of government debt securities and £0.4mn of other assets including coin and bullion. Against those assets, it had £2.0mn bank notes in circulation, £0.4mn of other deposits and liabilities and capital/reserves totalling £0.7m.

The BoE was set-up as a private joint stock company and it remained in private hands, even though it had long evolved into what we now understand to be a central bank, until 1946 when it was nationalized in the Bank of England Act5. This naturally begs the question: why did a private institution hold government bonds as the primary asset on its balance sheet? The answer can be found in the following paragraph in a Federal Reserve Bank of Cleveland publication6. It makes for interesting reading.

While these early central banks helped fund the government’s debt, [Ed note: My emphasis] they were also private entities that engaged in banking activities. Because they held the deposits of other banks, they came to serve as banks for bankers, facilitating transactions between banks or providing other banking services. They became the repository for most banks in the banking system because of their large reserves and extensive networks of correspondent banks. These factors allowed them to become the lender of last resort in the face of a financial crisis. In other words, they became willing to provide emergency cash to their correspondents in times of financial distress.”

From the very beginning central banks have been in the business of owning government bonds and facilitating the fiscal agent – the Treasury- in funding itself. Even though almost every central bank has now been granted operational independence to implement monetary policy - supposedly to free them political interference - they remain under public ownership. Curiously, one exception to this rule is the Fed which is both public and private. The Fed’s Board of Governors is an independent government agency, but the regional Federal Reserve Banks are private, owned by their member banks7. Given such history, is it any surprise that the primary – albeit not exclusive - way central banks “print” money is via purchases of government securities8?

When I say “print” I obviously mean metaphorically – hence the quotes - because we no longer inhabit a financial world where the predominant form of money is bank notes and coins. The overwhelming majority of payments are made using electronic money, money that is – by the way – created by private commercial banks. As I have pointed out in previous research notes9, the general public ie, non-bank sector cannot own publicly-issued money in any other form than bank notes and coins, at least not until the CDBCs are introduced10, the arrival of which has probably been hastened by recent events in the US. That is probably news to a lot of people11but “Hey, them’s the facts”. I digress.

Money From Nothing

In the world where money is electronic how does a central bank increase the money supply? Prior to the Great Recession, the most frequently used method was open market operations (OMO).

These are undertaken at the initiative of the central bank, unlike standing facilities which are at the initiative of private commercial banks, namely it is an active not passive operation from the central bank’s perspective.

New money is created by the central bank out of thin air (“printing” in other words) and is credited to the commercial bank’s account at the central bank in exchange for an asset, typically a government security12. Importantly, the bank reserves created in the process, which can be used to settle payments between commercial banks, are not - as mentioned - directly accessible by the general public. But, the resultant increase in base money13exerts downward pressure on short-term money market rates until the central bank’s interest rate objective is achieved14. Assuming the monetary transmission mechanism is not impaired, this in turn exerts downward pressure on the interest rates available to the non-bank private sector, which acts as a stimulant to the private sector to increase demand for bank loans. It is these commercial bank loans that create what most people think of as money. The person borrowing the funds uses them to purchase something – house, car, TV etc – money that goes into the seller’s bank account, resulting in the aggregate balance sheet of commercial banks increasing both on the liability (customer deposits) and asset (loan) side.

Hitting Rock Bottom

Since the Great Recession, central banks have relied on other ways to inject liquidity, most notably  quantitative easing (QE), also referred to as large scale asset purchases (LSAP). QE came about because during the Great Recession central banks found themselves hard up against the lower bound - the perception that nominal interest rates cannot go below zero, or at least not by much. Using OMO to drive down interest rates to stimulate the economy was impossible in such circumstances. The solution was for the central bank to go into the secondary market (buying direct from the government was a no-no because this would immediately lead to accusations of deficit financing which is verboten) and purchase government bonds (plus other assets adding a distinctly fiscal element to their monetary operations) in return for freshly “printed” electronic money.

At the time, and I recall this distinctly because I was working in the Fixed Income Department of one of the world’s largest SWF and had discussions with numerous market participants, many thought that this would inevitably lead to rampant inflation. Printer Go Brrr.

It didn’t of course, as we now know. Part of this reason why people anticipated higher inflation is because QE was very much an unknown quantity (no pun intended). As Ben Bernanke, who was Fed Chair at the time they implemented the first QE programme, later quipped:

the problem with Quantitative Easing is that it works in practice, but it doesn’t work in theory”.15

a reference to the Neil Wallace’s assertion that the composition or size of the central bank’s balance sheet does not impact either employment or inflation16. Nevertheless, central bankers put forward various mechanisms, or channels, by which they expected QE to stimulate or reflate the economy – see image below.

How QE Works

Printer Go Brrr: The Evolution of Central Banks Balance Sheets

Source: Bank Of England

Bernanke’s preferred channel was portfolio rebalancing as he outlined in the Fed’s annual symposium held in Jackson Hole in 2010. To wit,

the Fed’s strategy relies on the presumption that different financial assets are not perfect substitutes in investors’ portfolios, so that changes in the net supply of an asset available to investors affect its yield and those of broadly similar assets. Thus, our purchases of Treasury, agency debt, and agency MBS likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration.”17

In other words, by engaging in QE, the central bank assumes that it will influence investors to shift their investments away from safe assets towards assets with higher expected – or potential - returns such as equities, corporate debt and/or increase lending to firms and households. Like OMO, QE does not inject money directly into the non-bank private sector, the liquidity it injects in return for buying assets stays within commercial banks reserves. However, it is supposed to reflate the economy indirectly by incentivizing private sector agents to purchase other assets – generating a wealth effect – and to stimulate demand for private loans, which does – via the impact on the balance sheets of commercial banks - increase the money supply.

Wot, no inflation”

The reason why QE didn’t result in much higher inflation in the aftermath of the Great Recession is still a topic for debate. However, as I pointed out in a research note published back in 201418the primary way that QE works is via boosting asset prices and as a consequence it has a major side-effect: it directly increases wealth and income inequality19, or as others have quipped it’s “monetary policy for the rich”.

One of the fundamental assumptions in economics is that the marginal propensity to consume declines as a person’s income rises. Sounds fancy but it is really simply. For a person living hand to mouth they are likely to spend a larger proportion of a small amount of money (hence marginal) given to them than someone whose income is high. Money that is spent rather than saved is naturally more reflationary – consumption is not only the single largest component of GDP when viewed through the aggregate demand prism, but it constitutes someone else’s income and hence has an associated multiplier effect. Given QE “gifted” most of the income gains to the wealthy – the price of the assets they owned went up - and given their lower marginal propensity to consume, the multiplier effect was modest and hence the inflationary impact limited. So, strictly speaking, QE is “printing” money out of thin air (“Printer Go Brr”) but with no effect.

Actually, that is not entirely true. It did have an effect. QE did generate modest amounts of inflation, enough for the central bank to claim their were meeting their price stability mandates (2% inflation as a general rule), but because such “unorthodox” monetary tools are deployed when nominal interest rates are floored at zero it meant there was a prolonged period of negative ex post real interest rates20. This resulted in the purchasing power of fiat money dropping by more than 10 percentage points21- a magnitude of decline that is relatively unusual, at least in the developed world22. Let’s say instead, the printer made a gentle humming sound.

Post-Pandemic QE, however, had very different results. Of course, supply chain bottle necks played a role in lifting inflation initially, but by itself this would not lead to sustained inflation because this impact is analogous to a one-off jump in the price level. At least this is what central banks were assuming, which is why for much of 2021 they dismissed the rise as “transitory”. Russia's subsequent invasion of Ukraine, which pushed up the prices of key commodities, also obviously boosted inflation, but it does not readily account for the rise in core inflation, which strips out the effects of food and energy prices.

The best explanation for the sustained rise in inflation seen over recent years has been that QE was implemented in a very different manner during the Pandemic than during the Great Recessions. Because governments gave the money “printed” by the central bank directly to the public  - circumventing commercial banks - whose marginal propensities to consume where much higher than the (wealthy) beneficiaries of earlier QE programmes, the reflationary impact was corresponding greater23.

It is validation of the following statement made by John Cochrane, Senior Fellow of the Hoover Institution at Stanford24:

Both monetary and fiscal policy drive inflation. Inflation is not always and everywhere a monetary phenomenon, but neither is it always and everywhere fiscal.”

Takeaways

Central banks have fired up the “printing press” on multiple occasions over the past 15 years – that is interesting of itself for reasons I will go into in my next research note - but an inflation surge does not follow inevitably. That is a mistake a lot of people – especially in crypto - make and is perhaps why my use of the language was called out as being “loaded”. I know it doesn’t mean that but many others may not. Fair point. Sometimes “Printer Go Burrr” and nothing happens.

However, the key lesson from the Pandemic QE experience is that policymakers are not impotent when it comes to generating inflation. This is a myth that has been perpetuated and sustained by Japan’s “lost decades” and the benign inflationary aftermath of the Great Recession. The reality is inflation is a policy choice, one determined by both fiscal and monetary policy. Printer Go Burr is only half of the story.

Until next time.

Ryan Shea, crypto economist


1ATMs running dry is not a good look.

2See: https://www.bankofengland.co.uk/-/media/boe/files/ccbs/resources/understanding-the-central-bank-balance-sheet.pdf

3Outside money, such as gold and Bitcoin, does not have an associated liability except when they are being held on behalf of someone else – see: https://trakx.io/bitcoin-the-inside-out-narrative/

4Amazingly, there is data all the way back to 1696 – see: https://www.bankofengland.co.uk/-/media/boe/files/statistics/research-datasets/annual-data-on-the-boes-balance-sheet.xlsx?la=en&hash=DFB742A4438033D30B0A2E95A8606D1878C35D0F

5Cue Michael Caine impression.

6See: https://www.clevelandfed.org/publications/economic-commentary/2007/ec-20071201-a-brief-history-of-central-banks

7I appreciate there are many conspiracy theories about who owns the Fed, but this happens to be true as detailed by the St Louis Federal Reserve website – see: https://www.stlouisfed.org/in-plain-english/who-owns-the-federal-reserve-banks

8During their previous QE programmes, the Fed bought other financial instruments such as mortgage-backed securities (MBS), the BoJ purchased asset-backed securities and equities, while the SNB – out of necessity – refrained from QE and injected liquidity by purchasing foreign assets via FX unsterilised intervention. The necessity stems from the fact Switzerland is a relatively small open economy and the size of the domestic capital market is also quite small, making FX intervention a much better policy tool than QE as acknowledged by SNB Chairman Thomas Jordan in a 2020 speech at the BIS – see: https://www.bis.org/review/r200715n.pdf

9Such as this – see: https://trakx.io/roadmap-to-utopia/

10See: https://trakx.io/cbdcs-crypto-killers-part-1/

11Cue another Michael Caine impression.

12Historically, these assets were purchased outright but these days they can also be repoed. A repo is a repurchase agreement where one party agrees to sell an asset to another party while agreeing to buy them back after an agreed upon time period. Typically these are short-time periods, but there are such things as long-term repos (LTROs) first introduced by the ECB in 2011 – see: https://www.ecb.europa.eu/pub/pdf/other/mb201201_focus04.en.pdf .

13Base money equals the total supply of bank notes and coins plus commercial bank reserves held in the central bank.

14In the US when the FOMC announces its policy stance it references a target rate for the Fed Funds. Prior to 1994 monetary policy objectives for the Fed Funds rate were confidential and market participants only found out that the Fed’s monetary stance had changed when interest rates started moving - see: https://www.newyorkfed.org/medialibrary/media/research/epr/02v08n1/0205demi.pdf

15See: https://www.brookings.edu/wp-content/uploads/2014/01/20140116_bernanke_remarks_transcript.pdf

16See: https://www.jstor.org/stable/1802777

17See: https://www.federalreserve.gov/newsevents/speech/bernanke20100827a.htm

18See: https://www.blackswaneconomics.com/pdf/GMT%20-%20Identity%20Crisis_Part%201%20(2-5-14).pdf

19In the aforementioned research note I outline the mechanism by which this occurs, it relies on something know as the Kalecki profit equation.

20Ex post meaning nominal interest rates less realized inflation as opposed to expected inflation.

21After the post-pandemic inflation surge, fiat money’s loss of purchasing power measured this way now exceeds 20% - see: https://trakx.io/crypto-wager/

22For example, in the UK a drop of this amount has only occurred twice in the last 100 years.

23See: https://www.nber.org/system/files/working_papers/w27097/w27097.pdf

24See: https://johnhcochrane.blogspot.com/2022/08/the-fiscal-theory-of-inflation.html

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