The relationship between reserves and economic activity could also be more complex than traditionally thought. While higher reserve balances are sometimes related to more favorable financing conditions, recent research suggests that reserve accumulation may affect bank lending through balance sheet constraints.
On ECB Research Conference 2022, Researchers presented “The reserve supply channel of unconventional monetary policy,” This examined how large-scale reserve accumulation influenced bank lending under the post-financial crisis regulatory framework. The study found that other things being equal Additional reserves would crowd out bank lending because reserves and loans compete for balance sheet capability. From 2008 to 2017, it was estimated that each dollar of reserves injected displaced 19 cents of corporate bank loans.
Previous New York Fed research reached the same conclusion, noting that prime reserve balances may not stimulate credit creation and can have contractionary effects on credit under certain conditions. Taken together, these results suggest that reserve growth can support financial stability while constraining certain types of credit expansion.
This raises the chance that balance sheet expansion could contribute to reduced market volatility whilst lending conditions grow to be more restrictive. Such dynamics could help explain periods when asset markets remain resilient despite signs of economic slowdown.
