Central bank asset purchase programmes: how is money created and then destroyed?
Bulletin No. 248, article 1. Over the last decade, central banks have made extensive use of asset purchase programmes to tackle a number of crises. In addition to their impact on interest rates, these programmes have led to a mechanical and temporary increase in the amount of money in circulation in the economy. This article explains how the creation of central bank money, i.e. money exchanged in a closed circuit between the government, the central bank and commercial banks, is combined with the creation of commercial bank money held by businesses and households. The redemption of the securities held then gradually ensures the destruction of the money previously created. Since 2022, the Eurosystem has been reducing the amount of outstanding securities it holds by only partially reinvesting principal payments from maturing securities.
Over the last decade, conventional monetary policy instruments have proved inadequate to deal with the risks of market dislocation triggered by successive crises and of an inflation level that was, until recently, too low. Central banks responded to this situation by implementing non standard monetary policies, in particular quantitative easing (QE) programmes. These programmes were stepped up in 2020 in response to the economic and financial repercussions of the Covid 19 crisis. Since 2022, central banks paused these programmes before gradually exiting them by reducing the size of their securities portfolios in an orderly manner (quantitative tightening). Outstanding amounts at 31 December 2022 are shown in the Table 1.
Generally speaking, when a central bank increases the size of its balance sheet by purchasing securities, it finances these purchases by creating money in the commercial banks’ current accounts, in the form of central bank money, recorded as its liability and which it has a monopoly on issuing. This money circulates i) in the form of banknotes (“cash”) and ii) in the form of deposits (“non cash money”) which are held only by commercial banks, the central government, and certain institutions, i.e. the only entities authorised to open an account with the central bank. These purchases therefore do not have any impact on the money supply, i.e. the commercial bank money held and used by economic agents (households, corporations, and public administrations). However, central bank purchases are only one stage in the purchase programme, which involves solely previously issued securities.
In practice, in the euro area, if we take into account the entire life cycle of securities, we can see that the increase in central bank money to finance monetary portfolios has gone hand in hand with an almost equivalent increase in commercial bank money held by all non bank economic players (resident and non resident). The monetary and accounting mechanisms behind this dual increase in the monetary base, which should persist throughout the entire period during which the securities are held by the central bank, are described below.
The creation of commercial bank money associated with asset purchase programmes can also be seen in the recent developments of traditional monetary aggregates (i.e. restricted to residents) and their counterparts (Bê Duc et al., 2022).
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