It’s Not The What, It’s The How: Central Banks And Their Ever Expanding Balance Sheets

The balance sheets of central banks have massively expanded since the Global Financial Crisis in an attempt to help stimulate demand.

Between 2008-2015 the Fed’s balance sheet grew from $858 billion to $4.3 trillion. Relative to the US economy, this was a massive expansion from 6% of GDP to 25.4% of GDP. Similarly the Bank of England’s (BoE) balance sheet grew from 5.9% of GDP to 22.5% of GDP. However the biggest expansion was in Japan – where the balance sheet grew from 22.1% of GDP pre-crisis to 30% of GDP mid-2012, and then exploded to 65.4% of GDP in 2015 in the Abenomics climate. It is now a huge 320441.8 billion JPY.

The academic consensus suggests that little negative impact should be caused by ever expanding central bank balance sheets. This is as central banks are solely responsible for the liabilities that must be exchanged – i.e. cash – unlike private companies. And as central banks were not designed to be profit making entities, this transformation is not necessarily seen as negative. Furthermore, historical studies have suggested that the relative size of central bank balance sheets are merely returning to historical averages. [Ferguson et al; 2014]. Between the 1970’s to 2008, the financial sector growth of most economies outstripped the growth of balance sheets. Thus the post Global Financial Crisis period is a correction of this recent trend.

However the occurring downside of such an uncontrolled expansion is the theoretical inflation that may be caused. The policy of expanding balance sheets necessitates an increase of cash in the money supply. This money can then be leveraged upon and multiplied throughout the economy, and therefore generate uncontrolled inflation as a result.

Yet there is practical evidence to the contrary: the rates of inflation in the three countries above have been minuscule subsequent to the balance sheet expansion. Thus suggesting the connection is not as strong as believed. Although, it is highly likely that it was the unique characteristics of the 2008-2015 global landscape that were the cause of the low-inflation environment, and not a weakening of the money supply/inflation relationship.

Meanwhile others suggest that the core policy priorities – targeting the inflation target, closing the output gap and helping to ensure financial stability – far overshadow any debate on balance sheet size. [e.g. Eichengreen et al; 2015]. However this is a highly circumstantial argument – it is far easier to suggest the irrelevancy of the balance sheet whilst it remains <50% of GDP. As the relative size approaches and surpasses 100% of GDP, the argument loses some of its potency. And the feasibility of ever reducing its size exponentially decreases.

Still, it has been argued that attempting to return to pre-crisis level balance sheets would undesirably reduce the policy tools available to multi-laterally manage interest rates. [Friedman; 2014] This is because the central bank’s level of engagement with the money markets has increased as the trend has grown. Thus it is better placed than ever to actively manage interest rates.

Nevertheless, even if it is accepted that there is no negative impact to this expansion, such a narrative is blind to the political-economy impact that undertaking the post Global Financial Crisis strategy has entailed. The composition of the balance sheets have become heavily weighted towards assets such as securities – and ‘toxic’ securities at that. This has covertly supported only small sectors of the economy through alleviating previous bad business devisions by the recipients and as such has generated large moral hazard issues.

Furthermore, most of this direction has been undertaken without democratic oversight. Thus giving further unfair advantage to the beneficiaries of the policy. This pattern sets the stage for another crisis – although this time central banks will not be able to repeat their 2008-2014 trick again.

This being the case, it is important to recognise that although ever-expanding central bank balance sheets may be seen as ultimately harmless – it is in the nature and style of its undertaking that the true impact upon the economy will be felt.


– Eichengreen, B., Weder di Mauro, B. [2015]

– Ferguson, N., Schaab, A., & Schularick, M. (2014).

– Friedman, B. [2014]

© Patrick Tsui and, 2015. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Patrick Tsui and with appropriate and specific direction to the original content.


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