Quantitative easing and the hot potato effect: Evidence from euro area banks

• Published in: Journal of international money and finance Vol. 115; p. 102354
• Main Authors: Ryan, Ellen, Whelan, Karl
• Format: Journal Article
• Language: English
• Published: Elsevier Ltd 01-07-2021
• Subjects: Banks; Monetary policy; Quantitative easing; Monetary policy; Banks; Quantitative easing
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2021.102354

•We use bank-level data to examine the behaviour of reserves in the euro area banking system over the course of the ECB QE programme.•Previous research has often assumed banks passively absorb the additional reserves generated by QE.•We find evidence that European banks were actively seeking to push reserves off their balance sheets.•We report substantial month-to-month churn in bank reserves as well as evidence that banks are pushing reserves off their balance sheets through debt security purchases.•This effect, which we term the “hot potato effect”, seems likely to have had an effect on European bond yields that is distinct from the portfolio rebalancing effect that has been the primary emphasis of the existing QE literature.
We use bank-level data to examine the behaviour of reserves in the euro area banking system over the course of the ECB QE programme. Previous research on QE has often assumed banks passively absorb the additional reserves generated by asset purchases. However, with a negative deposit rate in place throughout our sample, euro area banks have had a disincentive to hold excess reserves and thus could wish to treat them as a “hot potato” that is preferably passed on to other banks. We find evidence for this hot potato effect, reporting substantial month-to-month churn in bank reserves as well as evidence that banks are pushing reserves off their balance sheets through debt security purchases. As such, this hot potato effect seems likely to have had an effect on European bond yields that is distinct from the portfolio rebalancing effect that has been the primary emphasis of the existing QE literature.