Central bank’s power stems from its ability to create reserves from thin air so as to buy assets or lend to borrowers
The use of the balance-sheet involves choices: which assets to buy, and how much.
As countries began locking down in spring 2020, an enormous shock reverberated across the financial system. Desperate for cash, investors dumped even safe Treasuries. Corporate-credit markets dried up.
Central banks reacted strongly. Between March and June 2020, writes Athanasios Orphanides of the Massachusetts Institute of Technology, the Fed created as many reserves as it had in its first 100 years.
The mere announcement of these policies stemmed market chaos
Following a doctrine laid out by Walter Bagehot, a former editor of The Economist, in the 19th century, central banks now act as lenders of last resort, standing ready to lend to sound financial institutions, against good collateral and at a penal rate, in order to prevent financial panics.
Non-banks conducted half of all financing activity worldwide in 2019. And it was these, not banks, that caused most panic in the pandemic.
Central banks also became buyers of last resort, both of government bonds and of commercial paper.
“The whole point of the Dodd-Frank Act in 2010 was to keep the Fed from intervening again,” says Mr Rajan. “But in 2020 it did everything and more. How do you get markets not to believe that you’ll do it again and again?”
The Economist 20 April 2022
Other monetary policy makers who have passed through MIT’s doors include Athanasios Orphanides, head of the Central Bank of Cyprus
Fed bought bonds at a pace of $120 billion, and continued making its final purchases in March