If the dismal science of economics has any imagination, it is in telling tales of central banks. Rumored to roam these institutions’ halls are cloistered technocrats, currency princes, and financial alchemists. Now, another character is stepping from fiction into the reality of the world’s most powerful financial institutions: the zombie central bank.
The era of zombie central banks is upon us. And it’s set to pose a political challenge for central banks that is unlike anything they’ve ever faced.
In economics, something becomes a zombie when, despite having negative profits as far as the eye can see, it continues to exist. Economists have documented the existence of zombie firms. They’ve even identified a few types, such as zombie banks, that recur throughout the world’s economies, like character archetypes recurring throughout the world’s folktales. The central bank is a new arrival to this taxonomy of economic zombies. Like the others, the zombie central bank runs a negative profit and is set to do so for the foreseeable future. Unlike the others, it is a central bank rather than a private firm.
In the traditional stories told by economists, central banks are the last creatures you’d expect to zombify. That’s because, at least in wealthy countries, they are supposed to have what today’s central bankers call “structural profitability.” A central bank prints money for free. But it can charge commercial banks for loans and services. That, the story goes, is an easy business. It would then seem to be difficult for central banks to turn into money-losing zombies.
But those old stories are outdated. In the 2000s, in the world’s wealthy countries, central banks rolled out a new policy tool. When interest rates were low, that new tool helped central bankers “optimize” monetary policy. Now that interest rates are higher, however, that tool is burning a hole through the balance sheets of central banks.
That policy tool is a process via which commercial banks “park” money at the central bank and receive a rate of interest, paid by the central bank, for that money. Between 1999 and 2008, the central banks of some of the world’s richest countries, including the United States, the European Union, Japan, and the United Kingdom, each adopted some version of this tool.
The economist George Tolley thought of this idea in 1957. Only in the 2000s, however, did central bankers encounter a new problem that prompted them to adopt it. The new problem? Commercial banks sometimes weren’t charging each other as much interest for short-term loans as the central banks would have liked. That was a problem because a primary way that central bankers influence the economy is by setting targets for the interest rates that commercial banks charge other commercial banks. If these bank-to-bank interest rates are falling below the targets set by central bankers, then the economy-wide cost of borrowing will be lower than the central bankers would like.
That cheap borrowing, in turn, typically means that spending is growing faster than central bankers would like. If spent on goods and services, that excess of spending creates excessive consumer price inflation. If on assets, it creates financial instability. And central bankers loathe inflation and financial stability. From their vantage point, in fact, the story of sagging interbank interest rates in the early 2000s likely ends up looking like a parable about the importance of their new tool. Low interest rates helped to burst the bubble in the U.S. housing market that caused a global financial crisis when it collapsed in 2007.
By offering a way to directly pay banks for depositing their money, central banks now prevent bank-to-bank rates from sagging. By turning itself into a player in the bank-to-bank lending game, the central bank can ensure that the bank-to-bank rate won’t end up too low. A bank won’t lend money to another bank for a lower interest rate than it can get if it deposits at the central bank. And so the interest rate paid by the central bank acts as a price floor in the market.
Until the last year or so, when interest rates were near zero or even negative, central banks didn’t pay a high-enough interest rate on reserves for the program to matter for their profits and losses. As late as March 2022, the U.S. Federal Reserve was paying 0.15 percent interest on bank reserves. The European Central Bank set its rate at -0.5 percent. (In practical terms, a negative value for these rates means that banks had to pay to deposit money at the central bank.)
That was then.
Now, surging inflation has prompted central banks to raise their main policy interest rates. Because the interest on bank reserves acts as a floor on the main policy rate, as main policy rates have risen so has the interest rate central banks pay to banks. Today, the U.S. Federal Reserve pays 5.4 percent interest and the European Central Bank pays 3.75 percent interest on bank reserves. That’s a recipe for zombification.
If central bankers let go of the central bank reserve tool now, they risk allowing interest rates to sag below their targets, as they did in the 2000s. That would effectively guarantee a loss in the central bank war against inflation. They can’t allow that. By keeping interest rates high and paying banks interest on reserves, however, central banks guarantee they will run negative profits for as far as the eye can see—and zombify.
So, what to make of the walking dead? After all, sometimes zombies are useful servants—and sometimes they’re brain-eating monsters. In terms of the significance of central bank profits and losses, the Anna Karenina principle applies. When countries have happy central banks, with positive profits, they’re all alike. Those profits go back to the government and ease the taxpayer’s financial burden. But when the banks are unhappy, with negative profits, each country is different.
The United States punts the financial burden to the future. When the Fed runs operating losses, it starts a tab with itself. The Fed then has to pay itself back with future profits before it can remit anything back to the Treasury Department. The Federal Reserve’s tab is now around $90 billion, and it’s growing. That is a burden for future generations already facing challenges ranging from entitlement reform to climate change.
The United Kingdom settles its tabs sooner. The taxpayer-funded Treasury needs to ship money to the Bank of England to cover its operating losses in something close to real time. According to one estimate, by 2028, the Bank of England’s zombification will effectively have transferred $157 billion from Britain’s households to its commercial banks.
But it’s the European Central Bank, based in Brussels, that may face a truly existential crisis from zombification. In the Euro area, it’s national central banks such as Germany’s Bundesbank that actually accept reserves from banks and pay interest on them. But they pay at a rate set in Brussels. Even beyond the question of whether and how Germany’s taxpayers have to pick up the Bundesbank’s tab, Brussels causing Berlin’s central bank to incur losses may, it seems, violate Germany’s constitution. At a minimum, that looks like another lever for recrimination between the European Union and member countries.
Japan’s desire to avoid central bank zombification has trapped it in the land of subzero interest rates. Even though inflation in Japan is running well ahead of its target, the Bank of Japan’s policy rate is -0.5 percent. That may be because in Japan, like the United Kingdom and unlike the United States, if the central bank runs an operating loss the government needs to pick up the bill in close-to-real time.
Because of how much cash commercial banks have deposited at the central bank in Japan, the country sits in a potential financial tsunami. According to one expert, if the Bank of Japan’s policy rate rose to just 0.5 percent, which would still be far lower than its peers in other advanced economies, the central bank would pay around 4 trillion yen (around $27.5 billion) per year to banks. That’s enough to more than wipe out the 1 trillion to 2 trillion yen in profits it now earns from its assets.
The case of Japan illustrates that central bank zombification raises the possibility of a financial version of Schrödinger’s cat, both alive and dead at the same time. But interpretations vary. If the Bank of Japan raised interest rates, creating operating losses, it would likely end up buying bonds issued by the government to…fund its own transfers to the central bank. The finances of Japan’s government would then seem to, at the same time, be both self-perpetuating and hopelessly, immortally self-defeating. Just as physicists and philosophers have now been debating Schrodinger’s cat for nearly a century, if this is what Japan becomes economists and legal scholars will be debating what to make of Schrodinger’s government balance sheet.
The current global era of central bank zombification is unlike the previous cases of central bank financial losses that economists have pondered. Those tended to be one-off losses from fluctuations in currency prices, or quirky cases in small developing countries. Today, by contrast, seemingly everywhere and all at once, the rich world’s central banks are losing money. And they’re losing it in the conduct of day-to-day monetary policy, not in quirky one-off ways. Even more quixotic is that these losses are arriving because of quasi-subsidies given to private banks.
This truly novel set of circumstances may imperil the one currency central banks can run out of: political capital. Elected policymakers, to the delight of central bankers, have historically granted central banks a thick degree of independence in the day-to-day conduct of monetary policy. But central banks have never before handed those who ultimately brought them into this world—taxpayers and voters—an outright bill with a balance poised only to grow over time.
The public mostly doesn’t like to think about banking, and when forced to it mostly hates it. Rallying cries such as “End the Fed” that emerged in the wake of the 2007-08 crisis, which fuels populism worldwide even today, greeted even bank bailouts that produced profits for taxpayers. And when farmers showed up with tractors to blockade the Federal Reserve’s entrance in the 1980s, the high interest rates lightening their wallets were not also mainlining cash to banks on Wall Street. At least for central banks, this time really is different.
Unlike other financial zombies, zombie central banks cannot run out of money. If they die or de-zombify, it will be due to a lack of political, rather than financial, solvency. What might that path back to the land of the living look like? Nobody, alive or zombie, really knows. That’s because the end of structural profitability for the rich world’s central banks marks the dawn of, if not the dead, at least something new.
