The fragile triangle: Price stability, bank regulation and central bank reserves

CEPR Policy Insight No 112

Hans Gersbach

This Policy Insight outlines how bank regulation and central bank reserves affect bank money creation, and how an examination of this link can contribute to the understanding of inflation risks. We suggest that as the tightening of bank capital regulation has come to an end and as banks maintain large central bank reserves, inflation risks are generally higher than currently assumed. While paying interest on reserves may be the easy solution, renouncing such payments, slowly reversing asset purchases, and setting temporary reserve requirements would make central bank reserves scarce again - with better monitoring incentives for banks and stronger mitigation of inflation risks.