Why the Euro remains a relatively strong currency.

• Author: Cecchetti, Stephen G.
• Position: OFF THE NEWS

In June 2012, the balance sheet of the European Central Bank peaked at over 3 trillion [euro]. Since then it has fallen every month, so that by the end of 2013 it stood at 2.2 trillion [euro]. Over this same period, the Federal Reserve's balance sheet rose from less than $3 trillion to more than $4 trillion. That is, as the ECB's balance sheet was falling by a quarter, the Fed's rose by a third!

One of the biggest reasons for this difference is that the two largest central banks have very different operating procedures. The result is that the balance sheets have a very different structure. At its peak, of the 3 trillion-plus [euro] worth of assets on its balance sheet, the "Consolidated financial statement of the Eurosystem" showed more than 1.2 trillion [euro] related to refinancing operations. These are repurchase agreements with the commercial banks of the euro area. By comparison, over 90 percent of the Fed's balance sheet is in the category labeled "Securities held outright."

Since European commercial banks decide whether to tender securities in a refinancing operation, they collectively determine the size of the ECB's balance sheet. And the fact that these banks want to shed reserves is what's behind the shrinkage over the past eighteen months. By contrast, the Fed can purchase securities and force U.S. banks to hold reserves. This balance sheet expansion, what is commonly known as "quantitative easing," has been the foundation of the Fed's...