Central banks want to learn from history. They can do so by drawing on decades of work by economic historians, as well as their own archives which manifest layers of institutional memory. But the path from page to policy can be difficult to find. Central banks need therefore to invest in the capacity of their own staff to think historically. This will help them use evidence from the past to make better decisions in the future. In practice, this means producing historical research as well as consuming it. Institutions like central banks need to be fluent participants in the conversations which bridge the distance between past and present.
Montagu Norman was the Bank of England’s longest serving Governor (1920-44) and one of the leading players on the interwar international financial stage. He was a controversial and enigmatic character who pioneered co-operation between central banks.
For the global economy, it was the best of times, and then it was the worst of times. Buoyed by very strong growth in emerging markets, the global economy boomed in the mid-2000s. On average, annualised world GDP growth exceeded 5% for the four years leading up to 2007 – a pace of growth that hadn’t been sustained since the early 1970s. But it wasn’t to last. In this post, I illustrate how the failure of Lehman Brothers in September 2008 coincided with the deepest, most synchronised global downturn since World War II. And I describe how after having seen the fallout of the Lehman collapse, macroeconomic forecasters were nevertheless surprised by the magnitude of the ensuing global recession.
In August 2007 problems were emerging in the US sub-prime mortgage market. Rising numbers of borrowers were getting behind on their repayments, and some investors exposed to the mortgages were warning that they were difficult to value. But projected write-downs were small: less than half a percent of GDP. Just over a year later, Lehman Brothers had failed, the global financial system was on the brink of collapse and the world was plunged into recession. So how did a seemingly small corner of the US mortgage market unleash a global crisis? And what lessons did the turmoil of autumn 2008 reveal about the financial system?
Paul Schmelzing is a visiting scholar at the Bank from Harvard University, where he concentrates on 20th century financial history. In this guest post, he looks at how global real interest rates have evolved over the past 700 years.
With core inflation rates remaining low in many advanced economies, proponents of the “secular stagnation” narrative –that markets are trapped in a period of permanently lower equilibrium real rates- have recently doubled down on their pessimistic outlook. Building on an earlier post on nominal rates this post takes a much longer-term view on real rates using a dataset going back over the past 7 centuries, and finds evidence that the trend decline in real rates since the 1980s fits into a pattern of a much deeper trend stretching back 5 centuries. Looking at cyclical dynamics, however, the evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable.
Michael Anson, Norma Cohen, Alastair Owens and Daniel Todman
Financing World War I required the UK government to borrow the equivalent of a full year’s GDP. But its first effort to raise capital in the bond market was a spectacular failure. The 1914 War Loan raised less than a third of its £350m target and attracted only a very narrow set of investors. This failure and its subsequent cover-up has only recently come to light following research analysing the Bank’s ledgers. It reveals the shortfall was secretly plugged by the Bank, with funds registered individually under the names of the Chief Cashier and his deputy to hide their true origin. Keynes, one of a handful of officials in the know at the time, described the concealment as “a masterly manipulation”.
Two of the country’s largest banks collapse. The subsequent panic brings the banking system to its knees and only a costly government bail-out prevents even greater catastrophe. A radical re-think of regulation is needed. No, it’s not London or New York in 2008. It is Berlin in the 1930s. It’s when risk-weighted capital regulation was born, notably to be used alongside a range of other tools; for example, liquidity requirements and such modern ideas as bonus deferrals and capital conservation. But the idea that no single regulatory measure is likely to be sufficient on its own was forgotten. In 2008 it had to be painfully re-learned making this episode a striking example of the importance of studying past financial crises.
What happens when a country’s banking system shuts down? Just how damaging is it to the economy? During the 20th century, the Republic of Ireland’s banking system suffered industrial disputes, some of which caused the main banks to close for several months. When Greek banks closed temporarily last year, some commentators (e.g. Independent (2015), FT (2015)) recalled how, previously, the Irish public ingeniously circumvented the banking system and kept economic activity going. Using material in the Bank of England’s Archive relating to the 1970 dispute, we shed light on how halcyon those days really were.
In June of 1974, a small German bank, Herstatt Bank, failed. While the bank itself was not large, its failure became synonymous with fx settlement risk, and its lessons served as the impetus for work over the subsequent three decades to implement real-time settlement systems now used the world over. Documents from the Bank of England’s Archive shed light on a lesser known aspect of Herstatt’s failure – the chain reaction it caused across financial centres as banks in different countries delayed settling their payments to each other. The lesson for policymakers today to grapple with is: when a bank fails, could we still expect surviving banks to delay making payments, with a potential chain reaction in the payment system?