Death of a Reserve Currency
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Death of a Reserve Currency
Stephen Quinn, TCUWilliam Roberds, Atlanta FRB
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Motivation
Quasi-fiscal activities can create substantial negative capital positions for central banks.
When, and how, does this undermine monetary credibility?
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Methodology
We generalize negative central bank capital into two states: potentially recoverable through internal means, or not so.
We reconstruct the balance sheet of the Bank of Amsterdam in the 1780s to see how, and when, the Bank lost its potential to recover and lost the credibility of its price stability goal.
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Why Amsterdam?
The Bank of Amsterdam’s florin was a dominant international currency.
Amsterdam was a top financial center built on merchant banks and a deep market for international acceptances.
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Conclusion
In 1782, the Dutch East India Company dragged the Bank of Amsterdam over the edge of monetary credibility.
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Before 1782
Bank of Amsterdam operated for decades with modest negative capital.
The Bank enjoyed substantial market funding.
The Bank’s money maintained a stable value.
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During 1782
The troubles of the Dutch East India Company degraded the quality of loans held by the Bank.
Markets withdrew wholesale financing.
Open market operations maintained the quantity of bank money.
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After 1782
It was no longer feasible for the Bank to recapitalize itself.
Market funding remained limited, and the value of bank money declined.
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Outline
1. Negative Central Bank Capital
2. Bank of Amsterdam Capital
3. 1782
4. The Fallen Regime
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1. NEGATIVE CAPITAL
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Modern Central Bank Balance Sheet
Assets Liabilities Government Bonds Money
Under Repo Banknotes in CirculationOutright Purchases Central Bank Accounts
Other Capital
Discount Window Assets less Liabilities GSE Bonds
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Negative Capital
Shock to asset values:• Exchange Rate Risk• Interest Rate Risk• Credit Risk
Can create technical insolvency:Capital < 0
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Problem?
NOUnlike commercial banks, a central bank can
create money to meet obligations.
MAYBEEmpirical observations suggest a threshold.
Why might negative capital matter?
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Intangibles
Unrecognized Assets
Franchise value
(the discounted stream of future monopoly rents)
Unrecognized Liabilities
Future claims
(Treasury expectations of siegniorage and quasi-
fiscal operations)
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Policy Insolvency
Inflationary Monetary Policy
Loss of credibility
Insufficient Revenue relative
to Negative Capital
Derived from Stella 1997: 9-10.
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Policy Insolvency
When a central bank cannot, “meet its policy commitments given its financial situation (Stella and Lonnberg 2008: 11).”
Can a central bank fund itself without resorting to destabilizing policies?
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MetricsTIME: The years it will take a central bank to recapitalize itself back to zero.
NET WORTH: What a risk neutral investor would pay for the central bank.
• Net Worth = Franchise Value + Capital
• Threshold when Net Worth = 0
• Net Worth ≠ Capital because of unrecognized assets and liabilities
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Central Bank Independence
Is the treasury creating policy insolvency by
reducing retained earning (seigniorage demands)
or depleting capital (quasi-fiscal operations)?
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Mission Creep
If the [central bank’s] seigniorage is regularly turned over to the treasury, and if the revenue grows very large, the treasury is likely to come to depend on it and to apply pressure to avoid its shrinking. In defense, the central bank is likely to be tempted to expand its mission, for example by undertaking to be a backup source of liquidity for a growing list of types of financial institutions. But such “mission creep” exposes the bank to new risks and therefore again to limitations on its ability to control the price level.
Sims (2004, p. 105)
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Bottom Line
Whether the demands of a treasury harm a
central bank’s other policies depends on the
central bank’s net revenue relative to its capital.
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2. BANK OF AMSTERDAM
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Table 1. Balance Sheet in 1780In Bank Florin
Assets Liabilities Silver and Gold Accounts Under Receipt 16,186,210 Under Receipt 16,186,210Unencumbered 3,817,229 Unencumbered 7,005,331 Loans East India Co. 2,600,000 Amsterdam 482,000 Holland 227,264 Capital 121,162 23,312,703 23,312,703
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The Receipt
When an account holder deposits a trade coin into the Bank, he receives– Account credit for the coin at its official value– A receipt which is an option to repurchase the
exact same coin after six months’ time, at a cost of ⅛-½ percent (depending on the coin)
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Bank Accounts
Accounts cannot be directly redeemed for coin without a receipt.• However, a daily secondary market for current
versus bank money exists.• Bank money customarily trades at a premium
(“agio”) over current money of 4-5%.
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Table 1. Bank Balance Sheet in 1780
In Bank Florin
Assets Liabilities Silver and Gold Accounts Under Receipt 16,186,210 Under Receipt 16,186,210Unencumbered 3,817,229 Unencumbered 7,005,331 Loans East India Co. 2,600,000 Amsterdam 482,000 Holland 227,264 Capital 121,162 23,312,703 23,312,703
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Table 1. Bank Balance Sheet in 1780
In Bank Florin
Assets Liabilities Silver and Gold Accounts Under Receipt 16,186,210 Under Receipt 16,186,210Unencumbered 3,817,229 Unencumbered 7,005,331 Loans East India Co. 2,600,000 Amsterdam 482,000 Holland 227,264 Capital 121,162 23,312,703 23,312,703
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City of Amsterdam
• Owns and administers the Bank of Amsterdam.
• Takes each year’s operating profits as seigniorage.
• Occasionally “borrows” from the Bank, but the city does not pay interest nor repay the principal.
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Table 2. Negative CapitalIn Bank Florin
Assets Liabilities Silver and Gold Accounts Under Receipt 16,186,210 Under Receipt 16,186,210Unencumbered 3,817,229 Unencumbered 7,005,331 Loans East India Co. 2,600,000 Amsterdam 482,000 Holland 227,264 Capital -360,838 22,830,703 22,830,703
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Policy Insolvency
Could a large amount of unbacked bank florins
threaten the goal of agio stability?
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Table 3. Negative capital
January Total AssetsCapital without
City Loans
Capital without City and East India
Loans1777 19,940,762 -422,3041778 20,471,697 -365,2631779 23,895,593 -416,1271780 23,312,703 -360,8381781 19,240,083 -460,1141782 20,961,397 -531,507 -5,331,5071783 19,779,899 -929,500 -8,579,5001784 18,234,566 -1,344,525 -8,994,5251785 19,724,727 -1,762,568 -9,412,5681786 18,962,014 -1,956,133 -9,606,1331787 19,090,538 -2,382,484 -9,802,9841788 18,597,782 -2,357,136 -10,771,2641789 20,681,724 -2,312,616 -10,997,244
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Table 4. Years to RecapitalizeJanuary
Operating Profit (bank florins)
Years without City Loans
Years without City and East India Loans
1777 59,696 7.11778 57,041 6.41779 65,873 6.31780 121,162 3.01781 139,886 3.31782 196,318 2.7 27.21783 144,865 6.4 59.21784 130,825 10.3 68.81785 73,717 23.9 127.71786 83,882 23.3 114.51787 62,754 38.0 156.21788 88,116 26.8 122.21789 96,431 24.0 114.0
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Table 5. Net WorthFranchise Value Net Worth
JanuaryUsing 3 percent
discount rate without City loans without City and East India loans
1777 1,989,881 1,567,5771778 1,901,366 1,536,1031779 2,195,753 1,779,6261780 4,038,743 3,677,9051781 4,662,859 4,202,7451782 6,543,927 6,012,419 1,212,4191783 4,828,823 3,899,324 -3,750,6761784 4,360,830 3,016,305 -4,633,6951785 2,457,239 694,671 -6,955,3291786 2,796,064 839,931 -6,810,0691787 2,091,813 -290,671 -7,711,1711788 2,937,193 580,058 -7,834,0701789 3,214,369 901,753 -7,782,875
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Figure 1. Stock of Bank Florins
1730
1734
1738
1742
1746
1750
1754
1758
1762
1766
1770
1774
1778
1782
1786
1790
1794
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
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Figure 1. Stock of Bank Florins
1730
1734
1738
1742
1746
1750
1754
1758
1762
1766
1770
1774
1778
1782
1786
1790
1794
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
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Figure 2. Price of Bank Florins: Agio
Jan-
30
Jan-
35
Jan-
40
Jan-
45
Jan-
50
Jan-
55
Jan-
60
Jan-
65
Jan-
70
Jan-
75
Jan-
80
Jan-
85
Jan-
90
-2
-1
0
1
2
3
4
5
6
Perc
ent P
rem
ium
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Figure 2. Price of Bank Florins: Agio
Jan-
30
Jan-
35
Jan-
40
Jan-
45
Jan-
50
Jan-
55
Jan-
60
Jan-
65
Jan-
70
Jan-
75
Jan-
80
Jan-
85
Jan-
90
-2
-1
0
1
2
3
4
5
6
Perc
ent P
rem
ium
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3. 1781 AND 1782
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Asset Shock
Fourth Anglo-Dutch War, 12-1780 to 5-1784
• British blockade • Dutch loss of Asian ports
British gain permanent free trade access to the Dutch East Indies.
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Figure 3. Dutch East India Co. Loans
Dec
-99
Dec
-77
Dec
-55
Dec
-33
Dec
-11
Dec
-89
Dec
-67
Dec
-45
Dec
-23
Dec
-01
Dec
-79
Dec
-57
Dec
-35
Dec
-13
Dec
-91
Dec
-69
Dec
-47
Dec
-25
Dec
-03
Dec
-81
Dec
-59
Dec
-37
Dec
-150
2,000,0004,000,0006,000,0008,000,000
10,000,00012,000,00014,000,00016,000,00018,000,000
Dutch East India Co. (VOC)
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Figure 3. Dutch East India Co. Loans
Dec
-99
Dec
-77
Dec
-55
Dec
-33
Dec
-11
Dec
-89
Dec
-67
Dec
-45
Dec
-23
Dec
-01
Dec
-79
Dec
-57
Dec
-35
Dec
-13
Dec
-91
Dec
-69
Dec
-47
Dec
-25
Dec
-03
Dec
-81
Dec
-59
Dec
-37
Dec
-150
2,000,0004,000,0006,000,0008,000,000
10,000,00012,000,00014,000,00016,000,00018,000,000
Dutch East India Co. (VOC)
Last interest payment by Dutch East India Company
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Figure 3. Plus Amsterdam “Loans”
Dec
-99
Dec
-77
Dec
-55
Dec
-33
Dec
-11
Dec
-89
Dec
-67
Dec
-45
Dec
-23
Dec
-01
Dec
-79
Dec
-57
Dec
-35
Dec
-13
Dec
-91
Dec
-69
Dec
-47
Dec
-25
Dec
-03
Dec
-81
Dec
-59
Dec
-37
Dec
-150
2,000,0004,000,0006,000,0008,000,000
10,000,00012,000,00014,000,00016,000,00018,000,000
Dutch East India Co. (VOC) Amsterdam
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Figure 3. Plus Amsterdam “Loans”
Dec
-99
Dec
-77
Dec
-55
Dec
-33
Dec
-11
Dec
-89
Dec
-67
Dec
-45
Dec
-23
Dec
-01
Dec
-79
Dec
-57
Dec
-35
Dec
-13
Dec
-91
Dec
-69
Dec
-47
Dec
-25
Dec
-03
Dec
-81
Dec
-59
Dec
-37
Dec
-150
2,000,0004,000,0006,000,0008,000,000
10,000,00012,000,00014,000,00016,000,00018,000,000
Dutch East India Co. (VOC) Amsterdam
“Deferred Asset”
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Figure 3. Plus Province of Holland
Dec
-99
Dec
-77
Dec
-55
Dec
-33
Dec
-11
Dec
-89
Dec
-67
Dec
-45
Dec
-23
Dec
-01
Dec
-79
Dec
-57
Dec
-35
Dec
-13
Dec
-91
Dec
-69
Dec
-47
Dec
-25
Dec
-03
Dec
-81
Dec
-59
Dec
-37
Dec
-150
2,000,0004,000,0006,000,0008,000,000
10,000,00012,000,00014,000,00016,000,00018,000,000
Dutch East India Co. (VOC) AmsterdamHolland
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Figure 3. Plus Province of Holland
Dec
-99
Dec
-77
Dec
-55
Dec
-33
Dec
-11
Dec
-89
Dec
-67
Dec
-45
Dec
-23
Dec
-01
Dec
-79
Dec
-57
Dec
-35
Dec
-13
Dec
-91
Dec
-69
Dec
-47
Dec
-25
Dec
-03
Dec
-81
Dec
-59
Dec
-37
Dec
-150
2,000,0004,000,0006,000,0008,000,000
10,000,00012,000,00014,000,00016,000,00018,000,000
Dutch East India Co. (VOC) AmsterdamHolland
Bank lends after public offer fails, and the Bank forebears interest on existing loans.
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Figure 3. Plus City Loan Chamber
Dec
-99
Dec
-77
Dec
-55
Dec
-33
Dec
-11
Dec
-89
Dec
-67
Dec
-45
Dec
-23
Dec
-01
Dec
-79
Dec
-57
Dec
-35
Dec
-13
Dec
-91
Dec
-69
Dec
-47
Dec
-25
Dec
-03
Dec
-81
Dec
-59
Dec
-37
Dec
-150
2,000,0004,000,0006,000,0008,000,000
10,000,00012,000,00014,000,00016,000,00018,000,000
Dutch East India Co. (VOC) AmsterdamHolland Loan Chamber (Beleen Kamer)
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Policy Insolvency?
Indicators of Market Sentiment
Receipt Accounts
Agio
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Liabilities: Account Ledgers
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Metal Assets: Coin Books
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Data Set
All changes in the Bank’s balance sheet
From January 1781 to January 1789
Aggregated to weekly observations.
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Figure 4. Receipt Run
Jan-
81Ju
l-81
Jan-
82Ju
l-82
Jan-
83Ju
l-83
Jan-
84Ju
l-84
Jan-
85Ju
l-85
Jan-
86Ju
l-86
Jan-
87Ju
l-87
Jan-
88Ju
l-88
Jan-
89
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
Cumulative Receipts
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Figure 4. Add Open Market Purchases
Jan-
81Ju
l-81
Jan-
82Ju
l-82
Jan-
83Ju
l-83
Jan-
84Ju
l-84
Jan-
85Ju
l-85
Jan-
86Ju
l-86
Jan-
87Ju
l-87
Jan-
88Ju
l-88
Jan-
89
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
Cumulative Receipts Cumulative Purchases
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Figure 4. Add the Agio
Jan-
81Ju
l-81
Jan-
82Ju
l-82
Jan-
83Ju
l-83
Jan-
84Ju
l-84
Jan-
85Ju
l-85
Jan-
86Ju
l-86
Jan-
87Ju
l-87
Jan-
88Ju
l-88
Jan-
89
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
0
1
2
3
4
5
6
7
Cumulative Receipts Cumulative PurchasesAgio
Perc
ent P
rem
ium
![Page 53: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/53.jpg)
Figure 4. Add the Agio
Jan-
81Ju
l-81
Jan-
82Ju
l-82
Jan-
83Ju
l-83
Jan-
84Ju
l-84
Jan-
85Ju
l-85
Jan-
86Ju
l-86
Jan-
87Ju
l-87
Jan-
88Ju
l-88
Jan-
89
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
0
1
2
3
4
5
6
7
Cumulative Receipts Cumulative PurchasesAgio
Perc
ent P
rem
ium
Until January 1783
![Page 54: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/54.jpg)
Figure 5. Open Market Purchase Rate
Jan-
81
May
-81
Sep-
81
Jan-
82
May
-82
Sep-
82
Jan-
83
3
3 1/2
4
4 1/2
5
5 1/2
Agio Purchase Rate
Perc
ent p
rem
ium
![Page 55: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/55.jpg)
Crisis in Sequence
1. Large debts become non-performing.2. This creates large negative capital.3. Wholesale funding withdraws. 4. Coin purchases stabilize bank money.5. Credibility of agio peg collapses
![Page 56: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/56.jpg)
4. NEW REGIME
![Page 57: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/57.jpg)
Figure 6. Receipt Levels
Jan-
81
Jul-8
1
Jan-
82Ju
l-82
Jan-
83Ju
l-83
Jan-
84
Jul-8
4
Jan-
85Ju
l-85
Jan-
86Ju
l-86
Jan-
87
Jul-8
7
Jan-
88
Jul-8
8
Jan-
89
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
Cumulative Receipts
![Page 58: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/58.jpg)
Figure 7. Open Market Operations
Jan-
81
Jul-8
1
Jan-
82Ju
l-82
Jan-
83Ju
l-83
Jan-
84
Jul-8
4
Jan-
85Ju
l-85
Jan-
86Ju
l-86
Jan-
87
Jul-8
7
Jan-
88
Jul-8
8
Jan-
89
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
Cumulative Purchases
![Page 59: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/59.jpg)
Figure 8. Agio
Jan-
81Ju
l-81
Jan-
82Ju
l-82
Jan-
83Ju
l-83
Jan-
84Ju
l-84
Jan-
85Ju
l-85
Jan-
86Ju
l-86
Jan-
87Ju
l-87
Jan-
88Ju
l-88
Jan-
89
0
1
2
3
4
5
6
Perc
ent P
rem
ium
![Page 60: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/60.jpg)
Figure 8. Agio
Jan-
81Ju
l-81
Jan-
82Ju
l-82
Jan-
83Ju
l-83
Jan-
84Ju
l-84
Jan-
85Ju
l-85
Jan-
86Ju
l-86
Jan-
87Ju
l-87
Jan-
88Ju
l-88
Jan-
89
0
1
2
3
4
5
6
Perc
ent P
rem
ium
Sales Rate at 3 percent
![Page 61: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/61.jpg)
5. CONCLUSIONS
![Page 62: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/62.jpg)
Conclusions
1. Quasi-fiscal lending gone bad pushed the Bank from technical insolvency to policy insolvency.
2. Markets ran from the receipt (repo) window.
3. The Bank lost its repo-based anchor on price level expectations.
![Page 63: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/63.jpg)
Implications
Some modern central banks use a similar mix of facilities in a similar way: a conservative side (ECB main refinance) creates credibility that extends to a more aggressive side (ECB outright monetary transactions).
Extensive aggressiveness plus a large collateral shock can flip such a central bank into policy insolvency and jar market expectations.
![Page 64: Death of a Reserve Currency](https://reader036.fdocuments.in/reader036/viewer/2022062323/568167b9550346895ddd07db/html5/thumbnails/64.jpg)
QUESTIONS?