“Circular Monetary Economics” will lessen the financial stability risks posed by ill-designed liquidity infusions from central banks

1) Can we lessen markets’ reliance on Central banks’ repo facilities, FX reserves and daily provision of liquidity whilst greening their balance sheets and reducing structural vulnerabilities in the financial system?

2) Do Central Banks’ provision of repo facilities to commercial banks increase financial stability risks by facilitating liquidity mismatches?

Synopsis: This paper argues for what I term “Circular Monetary Economics”, an approach to monetary policy that seeks to green and prudentially insulate the design and implementation of liquidity, repo, credit facilities by ensuring commercial banks green their loan operations, supply chains and inadvertently reduce vulnerabilities in central banks’ balance sheets as well as the cost of post-shock and crisis interventions. By utilising asset purchases, credit and liquidity facilities in a manner consistent with decarbonizing portfolios and boosting the potential growth rate via targeted investments and productivity-driven high paying jobs, central banks can achieve their inflation target, reduce structurally-driven balance sheet vulnerabilities in commercial banks’ whilst greening their balance sheets and approach to monetary policy. Circular monetary economics will lessen the probability of cross-asset contamination within financial institutions and contagion within the broader financial system, whilst simultaneously improving the transmissions from monetary and macro-prudential regimes in the event of a climate or credit-driven financial shock. 

Central banks such as the Bank of England, the Federal Reserve Bank and ECB target 2.0% inflation and output at varying intensities. Following the 2008 financial crisis, years of ultra-accommodative monetary policy and low or negative interest rates have caused a significant increase in Central bank’s balance sheets. The ECB’s balance sheet is currently worth more 4.2 trillion, while that of the FED and Bank of England are worth 3.8 trillion and 20% worth of GDP respectively. Meanwhile, central bank liquidity and repo-facilities reduce funding constraints; they must, however, green the design and implementation of their monetary and macroprudential (macropru) regimes in a manner that incentivizes the climate transition whilst insulating households & corporate balance sheets. Such an approach will bolster the effectiveness of macropru regimes and pass-through from accommodative monetary policy following periods of economic or financial shock. 

“Circular monetary Economics” will disincentives over-reliance on Central bank liquidity facilities and minimize financial stability risks

According to the BIS, repo market transaction or operations- depending on how one views their viability against structurally-driven amplification of shocks- offer a low-risk and liquid investment for cash, as well as the efficient management of liquidity and collateral by financial and non-financial firms. But the excessive growth of repo markets can also pose risks to financial stability over the long term. This is especially salient, given the credit-reliant financial and economic cycle that has been exacerbated by years of ultra-low interest rates that have prioritised the extension of global value chains whilst increasing the incidence of capital misallocation. Rather than cause financial stability risks per se, the increased reliance on short-term funding and repo facilities intensify the upswing in credit and financial cycles, whilst over-extending structurally-driven mismatches in commercial banks’ balance sheet. As such, the proliferation of financial stability risks must be averted via “Circular Monetary Economics”; an approach to monetary policy that seeks to green both central and commercial banks’ balance sheet and boost the potential growth rate. This will facilitate wage-driven, on-target, inflation outcomes. Additionally, such an approach, will lessen the adverse balance sheet effects of climate-centric shocks on corporate sector liquidity as well as risk-shifting to households via increased premium. The latter is driven by the marked fall in earnings following such events, as insurance pay-outs not only affect interest margins in the short-run, but also lessen the incentive for risk taking by commercial banks.

It is important to note that climate-centric shocks not only extend the time taken for economies to recover, it also lowers the potential growth rate, causes households to postpone purchasing decisions (spanning white goods, travel, home purchases) and increases the incidence of capital misallocation as low interest rates suggest an increased reliance on interest income even as tighter credit spreads lessen the incentive for risk-taking. “Circular monetary economics” will reduce sector-wide vulnerabilities, limit the risks of contagion across asset classes and amongst financial institutions.

Admittedly, repo rate transactions are indispensable to the efficient and smooth functioning of financial markets.

Although repo market operations are indispensable to the efficient functioning of financial markets; its functions, however rational, can amplify the likelihood of asset-specific or sector-wide shocks being amplified as it allows for structural vulnerabilities in asset classes and loan books to persist over the credit life cycle. As such, the necessary but fiscally deleterious act not only increases the cost of a shock to the financial system or crisis-centric response from central banks, it inflates the central bank’s balance sheet and exacerbates the dependence on market finance from already strained event-institutions. More importantly, is the extension of specific components of the credit cycle such as a lower Loan-to-Value ratio coupled with readily available liquidity, an inevitable consequence of central bank repo transactions, facilitates structurally-driven mismatches in portfolios and asset/credit flows. Circular monetary policy reduces the intensity stemming from structural-vulnerabilities latent in the asset and financial flows as well as capital structures. The latter appears increasingly driven by the balance of risks between the costs of holding debt versus equity.

Insulating the credit cycle via targeted amortization requirements reduce cross-asset contagion

In the UK, the loan-to-value ratio of the owner-occupied mortgage was loosened from 87.8% to 88.5% on December 4th, 2019. Meanwhile, the buyer-to-let loan-to-value was also loosened to 57.4% and 58.4%. The cumulative reduction of 25bps was accompanied by the continuous provision of liquidity to domestic banks. At first, this might suggest looser macroprudential standards, justified by an event-specific shock i.e. Brexit. Such an approach to lessening the adverse impacts of a specific shock is appropriate over the short term but should be utilised sparingly. The transient loosening in housing-related macroprudential tools has coincided with a dent in household credit growth and household debt to income ratio to 2.8% and 127.8% from 3.6 and 128.5% in Q3 2019. The lowering of macroprudential standards and continuous provision of liquidity undoubtedly stimulated the economy and lessened the impact of Brexit-induced uncertainty. It has, nonetheless, extended the current credit cycle and allowed structural vulnerabilities in current financing models to persist.

Stricter Amortization requirements are an important tool in the “Circular Monetary Economics”

Such outcomes suggest the appropriateness of amortization requirements throughout the credit life cycle, during a credit cycle upturn or at specific points of the credit cycle – contingent on household incomes and interest expense. It can therefore, be argued that the vulnerabilities latent in over-extended credit cycles are negated by rising property values and positive spill overs from balance sheet effects in the near term. Amortization requirements will lessen the adverse impacts of indiscriminate liquidity being provided to financial institutions and lessens the cross-asset contagion stemming from housing-related loans to other asset classes in banks’ balance sheets. Additionally, targeted amortization requirements comprise an effective tool in circular monetary economics, as it improves the transmissions from monetary policy in the event of a crisis and bolsters the resilience provided by the countercyclical buffer currently at 2.0%, capital conservation buffer, prudential regulatory capital, and Common Equity Tier 1 ratio. While these allow banks to provide vital credit functions such as lending, insurance savings and money management in the event of a downturn, they do not address the vulnerabilities latent in the design and implementation of current monetary policy frameworks.

Climate risks also constitute a financial stability risk and must now be embedded in Central Banks’ policy calculus. 

Although Central Banks’ mandates are constrained to achieving price and financial stability, climate risks (wildfires, floods, cyclones, soil erosion, torrential rain, and extreme temperatures) now constitute a financial stability risk as households and corporate balance sheets, financial assets and income receipts are exposed to extreme weather events via higher funding risks, loss of property and interest payments. The inevitable capital reallocation that inadvertently results following a climate-centric shock provides a rationale for a more expansive monetary and macroprudential policy, but the implications of such an approach falls outside the remit of this paper. Amortization requirements should be used ad-hoc but preferably throughout the credit life cycle in other to lessen household indebtedness.

“Climate change constitutes a financial stability risk; as such, liquidity operations, monetary and macrorpudential policy should address perceived vulnerabilities in the structural composition of asset holdings and loan books, whilst lessening the intensity of event specific shock on asset classes. Such an approach i.e “Circular monetary Economics” also reduces the risk of asset-driven liquidity mismatches stemming from redemptions or bank runs, as well as cross-contagion from varying types of shocks such as a sudden increase in funding or an event-driven shock”

A crisis-averse approach to policy design suggests lower interest for longer with a transient boost to productivity and wages.

Not only is residential and commercial real estate at risk, supply chains, factories, and asset portfolios are affected by extreme weather events. As a result, Central Banks will need to lower policy rates and fiscal policy will become more expansive, albeit responsive, causing tepid accelerations in the growth rate and below-target inflation at best. Such an approach to setting monetary policy suggests a more expansive balance sheet, lower interest rates for longer and an unfortunate reliance on fiscal policy to boost the potential growth rate. The latter holds true, as low-interest rates will likely be reflected in mortgage rates in spite of a 30% pass-through, while the cost of capital, rather than support growth, might simply seek to replace damaged infrastructure. As such, circular monetary economics will reduce capital misallocation, insulate commercial banks’ returns over the long-run whilst boosting the potential growth rate.

The impact of a more expansionary monetary policy cannot be understated, but the potential growth rate hinges on targeted investments in tech-centric sectors that facilitate diffusions across sections of the economy spanning digital services, ICT-related sectors, logistics, financial services, energy, transport, logistics, residential and commercial real estate, banking, fin-tech, education and manufacturing.

Extreme climate events reduce the effectiveness of macroprudential policy and the resulting response.

Meanwhile, extreme climate events such as floods, wildfires, heat waves, and cyclones could increase financial stability risks in spite of carefully designed and targeted macro-prudential measures such as adjusted loan-to-value ratios, capital conservation buffer, countercyclical buffer, and Common equity Tier 1 ratio. As such, monetary and macropru measures under such a context will only serve to replace lost property, and any gains in productivity and wages will be short-lived at best. The gradual attainment of the inflation target will be compounded by an increasingly leveraged corporate sector, whose reliance on low or negative interest rates equate the need, if not dependence, on central bank financing.

As I argue in an earlier paper, fiscal policy must be designed in a manner that facilitates the transition away from a low-productivity growth economy to one where the majority of the working population is employed in hi-tech and knowledge-intensive sectors. Between 2008 and 2018, the number of people employed in the knowledge-intensive sector in Iceland, the United Kingdom, France, Switzerland, Norway, and Sweden stood at 2.5%, 1.6%, 2.2%, 2.3%, 2.6%, and 2.3%. It is therefore imperative that crisis-centric monetary policy reform is conducted alongside targeted fiscal spending and labor market programs designed to address long term structural vulnerabilities such as an ill-equipped workforce for an increasingly digitized environment.

Financial loss bode ill for both corporate and households balance sheets

Furthermore, insurance pay-outs and premiums are set to rise following extreme climate events, whilst financial institutions are prone to more pronounced loses depending on the composition of their assets and loan books. Under such conditions, Central banks are poised to intervene by easing policy or injecting greater liquidity into the financial system. This will cause even more bloated balance sheets than Central Banks currently hold i.e. 4.2 trillion at the ECB, 3.8 trillion at the FED and 20% worth of GDP in the UK.

Not only does this signal an increasingly financialized economy, but it also suggests Central Bank liquidity and asset purchases might be overextending current maturities by transferring the risk latent in current debt holding (i.e short and semi-long term debt) into longer debt securities of varying maturities that take the form of debt issuances that are then purchased by the Central Bank. The extent to which liquidity and other repo transactions facilitate the transmission of policy rates to economic activity during a climate or macroeconomic shock provides an indication of the effectiveness of current macroprudential frameworks. Asset purchases only serve to introduce longer maturing debt into the financial and economic cycle; the structural mismatch made evident by a climate-centric or macroeconomic shock is only partially addressed as longer-term debt issuances are used to fund shorter-term debt liabilities.

In this context, the effectiveness of macroprudential policies appears to be much more contingent on the effectiveness of liquidity requirements and Net stable funding ratios. The extent of Central Bank intervention in money markets, not via asset purchases, determines the effectiveness of our current macroprudential frameworks. The mismatch that inevitably emerges from asset purchases, FX interventions, and money market operations allow a structural mismatch to linger. One that is not accounted for in macroprudential frameworks, which are designed to ensure sufficient credit serves as the basis for a post-shock recovery. As such, Circular Monetary Economics will serve to decarbonize Central Banks and financial institutions balance sheets, insulate their flows against climate risk over the long-term and reduce the cost of the Banks’ response

Current liquidity facilities appear insufficient, suggesting greater probability of mismatches and cross-asset contagion

The above will allow what I term “Circular monetary Economics” to facilitate the decarbonisation of asset flows and reduce financial stability risks whilst achieving Central Banks’ mandates of price and financial stability. Circular monetary economics entails greening the approach to Central bank repo transaction and liquidity provisions, which have become increasingly utilized as structurally-driven mismatches have emerged more strongly across the United States, ECB, and the UK. The extent and frequency of interventions determine whether structural mismatches are redressed over time.

This suggest that current liquidity requirements, as well as the Net Stable Funding Ratio, are unable to provide a sufficient buffer for banks, who should see liquidity as a pre-clearing facility rather than a persistent vehicle for finance. Meanwhile, the heterogeneity in liquidity distribution suggests such facilities might not be sufficient, which! suggesting a greater role for the Central bank in smoothing the functioning of markets. This dependence can allow the proliferation of liquidity mismatches which are likely to become increasingly evident in the event of a downturn or event-specific shock.

Moral hazards and climate unawareness increase the cost of future monetary policy  

As argued above “Circular Monetary Economics” will entail greening the provision of liquidity facilities; prioritizing banks with liquidity needs that are mostly linked to climate-centric projects such as wind farms, solar panels, and climate-centric infrastructure and technology. The outdated approach much-touted by Central bankers such suggests structural liquidity mismatches that are symptomatic of broader funding constraints, poorly designed liquidity and coverage ratios. The moral hazards that inadvertently results from such an approach cannot be understated as the ability for monetary policy to achieve the inflation over the long-term is significantly hampered. Meanwhile, macroprudential policy is less effective as climate shocks exacerbate the adverse impacts of liquidity provisions contingent on short-term financing needs. Admittedly, the risks of overextending credit cycles via debt issuances precipitated by increasing monetary accommodation amplify such an outdated approach to ensuring the smooth functioning of the financial system. This suggests the Central Bank’s unawareness not only facilitates funding for fossil-fuel intensive companies, but the practice of providing liquidity also further exacerbates financial stability risk and also suggest banks are much less capitalized than their current liquidity positions suggest. The moral hazards rooted in liquidity provisions are not only exacerbated by the Central Banks, they also constitute a moral hazard that reduces the incentive of a balance sheet-constrained approach to setting monetary and macroprudential policy. 

From a Central Bank’s perspective, a balance-sheet constrained – as argued by ‘circular monetary economics’ approach improves the effectiveness of monetary policy over the long term and lessens the structural mismatches that are amplified by ad-hoc and liquidity infusions via the money market operations. Some might regard a balance sheet constrained approach to money market activity as a signal that Central Banks are less willing to intervene in repo markets or provide liquidity to financial market participants. Whilst such rationale appears logical at first, it understates a, somewhat, dated approach to setting the Net Stable Funding ratio or liquidity requirements. The latter seeks to diversify sources of finance for financial and non-financial institutions, which should be facilitated by technology and lessen the need for idle liquid assets spanning cash, gilts, U.S T-bills. The use of the distributed ledger technology, can better align credit needs in the financial system with central bank liquidity and repo facilities. It can also allow for a more targeted approach to liquidity provision, one that aligns repo transactions and liquidity infusions with specific asset and loan types at varying maturities. In doing so, central banks’ can green their balance sheets, as well as incentivise productivity-boosting investments by facilitating the implementation of the distributed ledger technology.

A “balance sheet-constrained” approach to providing liquidity, prioritizes technology such as the distributed ledger technology that facilitates interbank lending and allows for a more pre-emptive ad-hoc intervention. One which reduces structural mismatches in the financial system and improves the effectiveness of the monetary policy.

Rather than these transient liquidity infusions into a financial system devoid of the distributed ledger technology (DLT) saw the FED inject over $170 billion into the financial period in a bid to reduce funding stress for financial institutions as liquidity needs rose abruptly due to tax payments and payrolls. These increasingly unjustified short-term bailouts suggest central banks are far from greening its monetary policy and liquidity operations. In other words, the Bank of England, ECB and FED’s approach to the provision of liquidity is devoid of “Circular Monetary Economics”. Not only will climate risks increase under such a scenario as poorly executed liquidity infusions are misaligned with broader structural reforms that are indispensable to ensuring smooth market functioning.

While interest rates have fallen across most advanced economies the potential growth rate has waned significantly, driven by increased capital misallocation. In the U.S. the potential growth rate has fallen by 2.6%, 2.4% and 1.7% between 1991 – 2005, 1999 – 2010 and 1.7% even as the FED cut interest rates by 500 bps in following the 2008 financial crisis. Meanwhile, despite interest rates currently being at 0.75% in the United Kingdom, the potential growth rate currently stands at 0.45%. As such, record low interest rates have done little to spur productivity-boosting investments. This is especially true as economies have become increasingly financialised, with the UK and U.S financial sector contributing 6% and 20% to GDP.

Central bank liquidity provision in their current forms are outdated and suggest structurally-driven mismatches to emerge more strongly

These liquidity infusions or interventions are justified by what banks perceive as “period of liquidity stress or volatility”. The unoriginal practice is outdated, archaic and fails to address structural mismatches and vulnerabilities in financial markets. As such, a market correction will be more pronounced as structural vulnerabilities will amplify funding needs, which are currently devoid of consideration in liquidity requirements and net stable funding ratios. Rather than simply provide liquidity, Central Banks’ should not only transition to a more advanced clearing system that facilitates the use of tokens (an outdated practice) for clearing and thereby reduce the need for daily liquidity provisions.  

The latter suggests that Banks are not sufficiently capitalized or hold fewer liquid assets than is warranted albeit carefully designed net stable funding ratios. Furthermore, this also provides an indication that daily trades (short-selling or otherwise) and other balance-sheet related risks are now accounted for via said liquidity infusions from central banks; hence shifting risk away from the financial system to the Bank’s balance sheet. In other words, the risks latent in short-term liquidity risks, rather than solely accrue to corporate spreads, also reflect the probability of said liquidity infusions. Admittedly, banks’ balance sheets can be as expansive as needed, but a financially deleterious approach to long-term financial stability is counterproductive, more so as monetary policy space is increasingly constrained due to record-low interest rates in most advanced economies. Given interest rates are poised to stay lower for longer, it is imperative that central banks redesign their approach to monetary policy. Furthermore, daily interventions are exacerbating capital misallocation in the financial system that amplifies structurally-driven impediments in the real economy and reducing the transmissions from record low unemployment to the inflation. This explains why unemployment is currently 3.6% in the US, 3.8 in the UK and 6.3% in the European Union even as inflation averaged 1.8% in both the U.S, U.K and harmonised inflation in the EU was 1.2%. As such, the Philips curve is likely weakened by liquidity and repo facilities in their current forms.

The commodification of central bank liquidity provisions has unintended consequences on the types and nature of finance for businesses in the real economy; it has also created a dependence on Central bank from market actors, which facilitates risk shifting ( via risk-absorption latent in quantitative easing), suggest inept liquidity requirements and Net Stable funding ratios. The inability for banks to use their buffers to finance short-term debt liabilities and daily liquidity suggests that a structural mismatch or what can be termed “Structurally-driven illiquidity” now plagues financial markets on a much more transient basis. As such the effectiveness of prudential policy hinges not on their ability to ensure banks can provide lending, savings, and insurance services by the ability of banks to smooth the transmissions from policy rates and provide liquidity.

For example, prompted by the potential risks that come with Brexit, the Bank of England has come to a similar conclusion to the FED and ECB, marking a decline in standards, which were previously stringent. More worrying is the fact that continued bank intervention suggests that liquidity and net stable funding ratio requirements are inadequate and the Central Banks are doing nothing more than maintaining an unsustainable funding model in the financial sector. One, which exacerbates the structural mismatches between short-term debt, longer-term liabilities, accounts receivables, and projected earnings.

One could argue that the value of share prices currently reflect projected earnings, debt profile and rating and macroeconomic outcomes of profit destinations. The continued access to liquidity can provide a better indication of how leveraged or sustainable financed companies are. After all the Net stable funding ratio and liquidity requirements were designed to ensure financial intermediaries can provide vital liquidity functions. The reliance on Central Bank funding suggests greater vulnerabilities currently persist or technology is ill-leveraged. Furthermore, these declining liquidity standards have become the new normal for Central Banks in advanced economies, who allow a significant divergence to emerge between their objective of financial stability and their inability to design technologically-driven clearing systems and funding model that reduce the risk of cross-asset contagion from collateralized loan obligations, small caps, equities or redemptions from investment funds.  

The continuous provision of liquidity to financial and non-financial institutions are misguided and ill-conceived  

Not only have Central bankers at the ECB and Bank of England noted the need for continuous and indiscriminate liquidity provisions, Benoit Coeur also noted the ECB has a contingent term repo facility that could be activated at a higher frequency if needed, and the BoE can lend to a very broad range of counter-parties against a wide range of collateral. This approach is wrong, misguided and economically counterproductive as it further increases the dependence amongst financial institutions and Central Banks, it also fails to allow monetary policy to achieve second-round effects such as climate change mitigation, the redirection of finance towards companies providing mini-grids, floating solar panels and precision agriculture.  

Companies benefiting from Central Bank liquidity must green their practices to support sustainable growth  

Commercial banks benefiting from central bank liquidity must provide clear details of their loan tranches allocated to green and carbon-intensive intensive, following strict reporting standards that link the provision of liquidity to specific loan types based on maturities. Unlike the liquidity provision mechanisms and repo transactions that facilitate liquidity mismatches via ill-regulated investment funds and continued provisions of liquidity mechanisms and ad-hoc interventions i.e. $170 billion for the Federal Reserve Bank which fail to include any governance approaches to their frameworks, with climate change or gender equity absent from their approaches. By forcing companies to green their balance sheets and localize or regionalize supply chains, not only will they green their loan books, insulate their interest-payments against sudden climate shocks, but it will also reduce the risk of cross-asset contagion and sector-wide imbalances from aggravating perceived shocks, exogenous or otherwise. Exogenous shocks include a sudden appreciation in the dollar and increases in interest rates; this is unlikely given the easing bias and ill-designed fiscal frameworks in advanced economies absent Germany, Netherlands, Sweden, Norway, Switzerland). 

The most counterproductive approach to central bank policy can be found in advanced economies, where rather than ease monetary policy aggressively and ensure a sustained convergence of inflation towards the inflation target, they choose a more gradualist approach that attempts to keep inflation expectations anchored rather than achieve the inflation target. The difference between Central banks such as the Riksbank and Norges Bank- who raised their policy rates in the previous years and continue to gradually move away from the lower bound or normalize monetary policy as it is currently referred – is their labor markets that are designed to ensure sustain increases in wage outcomes that align with inflation outcome whilst remaining competitive by international peers.

Framework for disclosure 

1) Standardizing climate change risk: Companies across sectors ranging from Information communication technology, digital payments, green energy & technology, health care, and manufacturing must disclose the materials used by their suppliers, their location, materials used in their supply chains ranging from computer components, solar panels nodes, etc. The reporting framework should be separated into three categories.  

·        Firstly, materials used to produce goods or services, mode of exploration and contribution to climate change.  

·        Secondly, they must disclose proximity to the suppliers, mode of transport.  

·        Thirdly, they must disclose competitors in the relevant sector and point-based rationale for choosing a specific supplier ranging from cost.  

2) They must disclose sources of finances for both companies and their suppliers, noting specific institutions, types of finance ranging from micro-finance loans to export allowances.  

3) They should attempt to discuss their liquidity needs and dependence on commodity ranging from processed petroleum, zinc, and rare earth metals in their supply chains, exposure to exogenous risks such as climate change, economic policy, and political uncertainty.  

By failing to address climate-vulnerabilities, central banks inadvertently increase financial vulnerabilities 

Central banks and regulators must also be clear that liquidity facilities and buffers are to be used only for financial and non-financial institutions who reduce dependence on external sources of finance such as the dollar that is prone to trade-induced fluctuations. This prompts the question: Are central banks promoting financial stability via macro-prudential frameworks such as the Loan-to-Value ratio which has been loosened in the United Kingdom from 87.3% and 88.1%. This means new home buyers will have to pay a 12.7% deposit to buy a new home. Furthermore, the Loan-to-income ratio has also been loosened from 3.8% in Q4 2018 to 4.2% in Q1 2019 as the countercyclical buffer was raised to 2% from 1% and the Common Equity Tier 1 was raised to 14% of the risk-weighted assets. As central banks’ balance monetary and macroprudential policy in their attempt to ensure a sustained convergence of inflation towards the 2.0 target, redesigning credit and liquidity facilities will green their balance sheets and incentivise forward-looking investments in capital markets.

However, the inability to utilize liquidity and reserve requirements to incentivize the greening of loan operations and firm balance sheets suggests that Central Banks are inadvertently increasing financial stability risk by failing to reduce balance sheet vulnerabilities. Not only is this the reverse of their mandated targets and responsibilities, by failing to address vulnerabilities which fall within their remit, they increase the intensity of corrections. For example, in October, Central Banks clarified our supervisory expectations to re-emphasize their commitment to providing liquidity in the ordinary course of business. We do not expect firms to justify any usage, nor is there any presumption they would use their own buffers before our facilities. Next year’s first system-wide liquidity stress test will be another opportunity to demonstrate that liquidity buffers are fully useable. 

Green solutions can enable central banks and commercial banks green their balance sheets at a faster pace 

Furthermore, companies that provide green technology and energy can collaborate with in-door biking companies to enable people generate and store electricity from green technologies and create a smart energy network where electricity generation is not contingent on wind or sun, but also from in-door exercise like bike riding. By incentivizing the greening of loan provisions via liquidity and reserves at the bank, money-market operations will cause banks to green their balance sheets whilst commercial banks reduce balance sheet vulnerabilities by providing credit in a manner that lessens balance sheet vulnerabilities, cross-asset contamination and limits industry-wide shocks. As such, it is indispensable for “circular monetary policy” to be normalised by central banks. 

Furthermore, this will improve the transmission mechanisms from policy rates in the event of stress, but lessen the contractionary effects of insurance premiums and damage claims, reduce the incentive to utilize the countercyclical buffers, capital conservation buffer to reduce the impact of shocks on varying asset classes. It is, therefore, imperative if not indispensable that central banks green their balance sheets by enforcing “Circular Monetary Economics”.

This paper argues for a, somewhat, radical and timely change to liquidity and repo facilities that incentivize a greening of loan activity and firms’ balance sheet. This will facilitate the pass-through from monetary policy via what I term “circular monetary economics” and lessen the reliance on Central bank liquidity functions. By boosting the potential growth via targeted and carbon-neutral investments, wage-driven inflation will boost domestic demand, cause inflation to converge towards target.

Keywords:

Circular monetary policy: a practice whereby Central Banks prioritize the provision of liquidity facilities and asset purchases to commercial banks based on the extent to which they green their balance sheet.

Reference.

1)      Repo market functioning (April 2017). Committee on the Global Financial System, Bank for International Settlements.

2)      Christopher Witko, (2016), How Wall Street became a big chunk of the U.S. economy — and when the Democrats signed on.