DP19057 Central bank capital adequacy; the simple analytics and complex politics
Many central banks have incurred significant operating losses since 2022. With assets priced at fair value, many central banks have also incurred unprecedented balance sheet losses and have deeply negative equity. Fortunately, irredeemable central bank money is a liability in name only.
The Fed and the ECB record losses that would bring equity below some threshold as a positive asset or negative liability to their conventional balance sheets. This deferred asset is a misleading version of an implicit liability in their comprehensive balance sheet or intertemporal budget constraint—the present discounted value (PDV) of net remittances to the national Treasury.
A central bank without significant foreign-currency liabilities can avoid insolvency by increasing the PDV of seigniorage. If this threatens its inflation or financial stability mandates, its solvency and effective pursuit of these mandates may require indemnification of its losses or recapitalization by the Treasury. This may pose a threat to its independence.
