Maintaining Central-Bank Solvency under New-Style Central Banking

Since 2008, the central banks of advanced countries have borrowed trillions of dollars from their commercial banks in the form of reserves and invested the proceeds in portfolios of risky assets. They are paying interest on those reserves. We investigate how this new style of central banking affects central banks’ solvency. We find that a central bank that pays dividends equal to net income will always be solvent, but if the central bank is not recapitalized when net income is negative, or other precautions are put in place, then reserves will tend to grow more in crises than they shrink in normal times. We compute measures of the financial strength for the Federal Reserve and the European Central Bank and find that the main risk to their solvency comes in the recovery from the crisis, when they suffer capital losses on their large bond portfolios. For both central banks, we conclude that the risks to their solvency as of 2013 are remote. JEL E31 E42 E58 ∗Hall’s research was supported by the Hoover Institution. This research is part of the National Bureau of Economic Research’s Economic Fluctuations and Growth and Monetary Economics Programs. We are grateful to Monika Piazzesi, Chris Sims, and Michael Woodford for helpful comments.