Surplus reserves in the banking system are common in countries across the world. They arise where the banks’ working balances on accounts at the central bank persistently exceed the required level of reserves. In other words, surplus liquidity occurs where cash flows into the market for reserves continuously exceed cash flows drained into the central bank. This can occur in any economy, but, historically, Soviet, wartime and transitional countries have been among the most prone to liquidity surpluses. Transitional economies, for example, often attract large capital inflows as the economy opens and undergoes privatisation. In the wartime economy, consumption is restricted and large amounts of involuntary savings accumulate until goods and services eventually become more widely available. Soviet-style economies have displayed widespread shortages and administered prices. This creates a situation of repressed inflation, whereby prices are too low relative to the money stock, leaving individuals with excess real balances. Clearly, the incidence of surplus liquidity is wide and may have important implications for both central bank policy and operations.

The objective of the paper is to define carefully the way in which surplus liquidity arises, how far in practice this represents a problem for central banks and, if so, what the possible responses might be.