Catherine R. Schenk
The Bank of England co-organised a ‘History and Policy Making Conference‘ in late 2020. This guest post by Catherine Schenk, Professor of Economic and Social History at the University of Oxford, is based on material included in her conference presentation.
Since the Great Financial Crisis started in 2007 there has been renewed interest in using the past as a basis for policy responses in the present, but how useful is history and how is it best used? Certainly, the old chestnut that ‘those who neglect the past are sure to repeat it’ is a valid warning, but how to select the appropriate historical examples and draw the right lessons is a more nuanced exercise that is explored in this post.
- Galbraith (1990): ‘the extreme brevity of the financial memory’ makes financial markets susceptible to unstable euphoria.
- Greenspan (1997): ‘regrettably, history is strewn with visions of such ‘new eras’ that, in the end, have proven to be a mirage. In short, history counsels caution’.
- Macmillan (2008): ‘the past can be used for almost anything you want to do in the present’.
- Bernanke et al (2019): ‘Financial crises recur in part because memories fade’.
Perhaps we need to think beyond just crises when we consider how history can be helpful to central bankers. The essence of economic history is to highlight the importance of institutions and the political and social context of economic outcomes. Knowing about how policies were developed in the past can enhance our understanding of the changing context of policy implementation. To do this, uncovering in the archives the options that were rejected might be as important as assessing the impact of policies that were adopted. More broadly, historical case studies can be used as a training ground for central bank staff and broaden their conceptual or theoretical imagination by challenging current ideas of what central banks are for and what their priorities should be. This may become increasingly important as the central banking orthodoxy from the past 30 years begins to break down. Central banks will need flexible minds to face future challenges. Finally, of course, economic historians create long-term data sets to provide the raw material to test and inform shifts in economic policy. The Bank’s Millenium of Macroeconomic Data is a good example of this. In 2009 at age 94, Paul Samuelson’s advice to economists was ‘Have a very healthy respect for the study of economic history, because that’s the raw material out of which any of your conjectures or testings will come’.
Using the past in 2008
In 2008 the main anchor for central bank responses was the Great Depression of the 1930s. With historians of this crisis in key policy posts in the US (such as Ben Bernanke and Christina Romer) the lessons seemed to be clear: loosen monetary policy to avoid worsening the banking crisis. This lesson was drawn directly from Friedman and Schwartz’s 1963 classic A Monetary History of the United States. And the collective memory of the 1930s was not restricted to academics turned policymakers. Romer (2013): ‘was amazed at how much he [President Obama] knew about the 1930s and how incredibly intellectual the discussion was’ when she joined his Council of Economic Advisers.
But as Barry Eichengreen (2015) and others have pointed out, some of the lessons of the 1930s gained less traction after 2008: in particular the risks to recovery from an early reversal of fiscal stimulus led to renewed recession in the United States in 1937–38, but governments turned quickly back to balancing their budgets after 2010. In part this reversal responded to another historical lesson drawn from Reinhart and Rogoff’s 2009 book This Time is Different about the threshold of debt/GDP beyond which risks of further financial instability increased. This shows that history can deliver contradictory advice; the academic debate about this threshold continues. What is clear is that this time really is different because that threshold has been vigorously breached in response to the 2020 Pandemic.
The past rejected: ‘Apocalypse Now’
One example of using the past from the Bank of England archives is a little known exercise internally known as ‘Apocalypse Now’ (Schenk (2021)). At the end of the 1970s the Bank began to prepare for a systemic banking collapse arising from a sovereign debt crisis – a few years before Mexico’s threatened default prompted the largest ever sovereign debt crisis in 1982. Their first approach was to analyse the 1931 collapse of the Credit-Anstalt bank in Austria that set off a European financial crisis. Drawing on their own archives as well as histories of the episode, the Bank’s staff concluded inter alia that central bank co-operation through the Bank for International Settlements in advance of a potentially contagious banking crisis was needed. They then took their scenario planning to the BIS in 1981 to discuss with other G10 central banks. Unfortunately, other central bankers were less convinced that the past was a useful guide to the future and the effort to create a framework for dealing with the looming crisis failed. In this case potential lessons from the past were ignored and the sovereign debt crisis struck without a coherent institutional framework in place. The ad hoc resolution process was long drawn out and debt forgiveness was only introduced seven years later.
The past forgotten: Central Bank Swaps
When the US Federal Reserve introduced a system of bilateral swaps with central banks in Europe, Japan and seven other countries 2007–08, it was praised as ‘one of the most notable examples of central bank co-operation in history’ (Obstfeld et al (2009)). But it was not completely new. The Federal Reserve swaps with central banks started in 1962 and grew by the end of the decade to the same relative volume as the facilities available at the time of the Lehman Bros collapse in September 2008. The swap facilities in the 1960s were even larger than these later swaps in relation to global foreign exchange reserves (c.30%). Together with short-term credits among other central banks, the system thus represented a massive contribution to the global financial safety net. Moreover, while their most frequent purpose was to fund foreign exchange intervention to manage exchange rates, in the 1960s the swaps were also used to achieve similar sorts of outcomes to 2008. The Fed used its swap lines with Switzerland and with the Bank for International Settlements to channel dollars onto the balance sheets of banks outside the United States during seasonal and other periods of tightening in the offshore dollar market to ease liquidity, dampen interest rates and reduce the drain of funds out of New York (McCauley and Schenk (2020)). The minutes of the FOMC when the swaps were renewed in 2007–08 make no mention of this particular type of swap in the past. If central bankers had reflected on how central bank swaps were used to manage liquidity in the offshore dollar market in the 1960s, they may have taken inspiration from the role of the Bank for International Settlements or been less concerned that the swaps might be misconstrued either as an effort to support the US dollar exchange rate or for bailing out foreign banks. The early swaps system survived for 35 years before being suspended in 1998 for 10 years until the great financial crisis threatened global dollar liquidity at the end of 2007. In the wake of the 2020 pandemic the swaps were enhanced and new repo facilities were introduced for other central banks, confirming their place in the global financial safety net. In April 2021 the Bank of England and BIS announced a new sterling liquidity facility.
What’s next? Pandemics, finance, technological change
What other recent historical research might be useful for central bankers? There is a large body of research on the economic impact of pandemics in the past, collected by the Economic History Society. Shiller’s (2020) narrative framework includes the 1920–21 recession in the United States after the global flu pandemic, race riots and divisive ideological extremism and highlights the risks of deflation. Conversely, Goodhart and Pradhan (2020) take a longer view of demographic change after the pandemic to suggest that inflationary pressures will reappear. In this age of digital currencies and artificial intelligence, Quinn and Turner’s (2020) history of booms and crashes also emphasises the role of technological innovation and policy shocks as ‘sparks’ setting off bubbles. The pandemic has also given a further fillip to research on the epidemiology of financial crisis (eg Accominotti (2019) and Blickle et al (2020)). At a global level, the contraction of the correspondent banking network since 2008 (BIS (2020)) suggests that we can learn much from how international payments responded to technological, economic and political shocks in the past. This is the theme of a new project launched in March 2021 to reconstruct the architecture of the international payments system from 1870–2000 (GloCoBank).
In sum, history provides a playground for policymakers to apply data or scenarios to their policymaking and to provide inspiration for thinking outside the box. But the pursuit of lessons from economic history must be carefully calibrated to the underpinning institutional setting – this nuance calls for greater collaboration between economic historians and central bankers.
Catherine R. Schenk is a Professor of Economic and Social History at the University of Oxford.
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