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F. Papadia: Until when will the US and the Euro-area be awash with central bank liquidity?

image-05/30/2016 - 11:20If you are impatient, my tentative answer to the question in the title is: 2022 for the US and 2028 for the Euro-area, meaning that we can expect another 6 years of abundant central bank liquidity ) in the US and a dozen years in the Euro-area. If you bear with me a while longer, I can explain how I reach this, I believe surprising, result, and why it matters.

The history of central bank liquidity over the last decade or so in the US and the Euro-area, but also in other advanced economies like the UK, is very simple. Until the beginning of the Great Recession, both the Fed and the ECB only gave banks the liquidity they needed to satisfy reserve requirements and autonomous factors. Basically, they targeted zero excess liquidity. This set the policy rate, the Federal Funds Rate in the US and EONIA in the Euro-area, practically in the middle of the corridor between the absorbing (bottom) and the providing (ceiling) central bank liquidity facilities.

While sharing this fundamental analogy, the Fed and ECB frameworks were different in some respects. The most important difference was that the law did not allow the Fed to pay interest on bank reserves, and thus the bottom of the corridor for the Fed was fixed at 0, while the ECB could remunerate reserves and thus move the bottom together with the entire corridor.

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Francesco Papadia is the chair of the Selection Panel of the Hellenic Financial Stability Fund (HFSF) and a SEP Senior Fellow. He was, between 1998 and 2012, Director General for Market Operations at the European Central Bank. He worked previously at the Banca d´Italia, first as Director of the International Section of the Research Department and then as deputy head of the Foreign Department. Mr. Papadia has a degree in law from the University of Rome and attended postgraduate studies in Economics and Business at the Istituto Adriano Olivetti in Ancona and at the London Business School. Follow him on and Twitter (@FrancescoPapad1).