DP6827 Can Central Banks Go Broke?

Author(s): Willem H. Buiter

Publication Date: May 2008

Keyword(s): central bank insolvency , lender of last resort , market maker of last resort , recapitalising central banks

JEL(s): E31 , E41 , E44 , E52 , E58 , E63 , F31 , F41

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6827.asp.asp

Central banks can go broke and have done so, although mainly in developing countries. The conventional balance sheet of the central bank is uninformative about the financial resources it has at its disposal and about its ability to act as an effective lender of last resort and market marker of last resort. As long as central banks don’t have significant foreign exchange-denominated liabilities or index-linked liabilities, it will always be possible for the central bank to ensure its solvency though monetary issuance (seigniorage). However, the scale of the recourse to seigniorage required to safeguard central bank solvency may undermine price stability. In addition, there are limits to the amount of real resources the central bank can appropriate by increasing the issuance of nominal base money. For both these reasons, it may be desirable for the Treasury to recapitalise the central bank should the central bank suffer a major capital loss as a result of its lender of last resort and market maker of last resort activities. The fiscal authorities of the Euro Area should as a matter of urgency agree on a formula for dividing the fiscal burden of recapitalising the European Central Bank/Eurosystem, should the need arise.