The equity of a corporation is the difference between its assets and liabilities. Under typical accounting practice for central banks, transferring cash directly to households would result in a decline in their accounting equity, because cash is treated as a liability. So one consequence of central bank direct support for consumption is a decline in their accounting equity. Does this matter?
Equity matters to private corporations because if their liabilities are high relative to their assets they may go bust, i.e. fail to honour payments to creditors, workers, suppliers etc. You may already be thinking that this doesn’t really apply to central banks. The central bank actually prints money (notes, coins and the electronic equivalent – bank reserves), so it is obvious that there is no circumstance where it doesn’t have the ability to meet a payment in domestic currency. The concept of ‘equity’ seems irrelevant.
As is often the case in this area of economics, that simple intuition is in fact correct, and economists who are often rigorous in their maths, lack anything approximating rigour in their semantics.
Economists are asking a separate question, ‘Does the central bank’s accounting equity affect its ability to meet its inflation target?’ We can frame this question more accurately. When central banks transfer cash to households in direct support of consumption, base money rises. So the question is really simple: does the central bank’s balance sheet ever constrain it from either contracting the stock of base money, or restricting the effects of base money on the banking system’s balance sheet growth? The answer to this is really clear. Central banks can always limit the effects of base money on inflation by either raising the amount of reserves that banks are required to hold and by using tiered reserves – i.e. having different interest rates on different classes of reserves. Accounting equity is not relevant.
1. This note is a response to discussions on social media inspired by this superb article by the Czech central bank on what central banks can do to support economies if interest rates are already low and recession strikes. They provide empirical support for the fact that there appears to be no link between central bank equity and inflation outcomes. I reach the same conclusion deductively.