Download Financial Crises, Globalization and the Currency Composition of

Writing Central Bank and
Monetary History
- What is the issue?
Michael D. Bordo
Rutgers University and NBER
Norges Bank and Graduate Institute of International and Development Studies. Geneva October 30-31, 2008
Monetary History and Business Cycles

Key problem for mercantile and industrial economies is business
cycle – goes back to the 18th century

Central banks have been assigned the task of stabilizing the real
economy since the 1930s

Before then real stability not viewed as important as price
stability and financial stability. Belief that providing stable money
and financial stability would create stable real environment.

Under the gold standard business cycle and price cycles were
correlated . CBs followed rules of the game
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Monetary History and Business Cycles

Growth of suffrage , labor unions made domestic real stability a
political goal

This led to a new task for CBs

Countercyclical policy and belief in full employment comes
from Keynesian economics in the 1930s . Classical view is wages
would adjust and unemployed could emigrate to America..

Great Depression caused by poor monetary policy in US and
elsewhere - followed bad theories - real bills doctrine led to
procyclical policy
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Monetary History and Business Cycles

Keynesian era . CBs fine tune. Target low unemployment. Follow
Phillips curve tradeoff, attach lower welfare costs to inflation than
unemployment

Friedman ( 1953) shows stabilization policy is destabilizing.
Friedman and Schwartz ( 1963) show that monetary policy in US
explains cyclical instability, Friedman ( 1969) shows that Phillips
curve is vertical in long run. Lucas( 1973) Rational expectations
show Phillips curve vertical in short run.

Great inflation 1965 -82 leads to change in thinking away from
using countercyclical monetary policy
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Monetary History and Business Cycles

Business cycles often reflect real shocks, CBs can accommodate
them but should not offset them, eg oil price shocks of the 1970

Politics very important. Employment Act of 1945 in US. Similar
legislation in other countries makes full employment a goal of
monetary policy. Creates Dual Mandate in the US

Central banks follow Taylor rules but weights on output and
inflation differs across countries
Modern emphasis on inflation targeting( explicit and
implicit)argues that real economy will be more stable in an
environment of low inflation


To organize a study of a central bank’s history , it may be of value
to categorize policy regimes by weights in the Taylor Rule.
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Session II(continued)
Monetary History and the Monetary Policy
Framework

The central bank uses its tools of monetary policy to affect the
supply of money and credit

Three key goals of monetary policy:
– Price stability
– Stable real economy
– Financial stability

The history of central banks goes back to the 17 century Riksbank
1668, Bank of England 1694

Joint stock banks of issue established to aid in government
finance
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Session II(continued)
Monetary History and the Monetary
Policy Framework

Also engaged in private banking business

As bankers banks became LLR

Later CBs established beginning of 19C, Bank de France 1800 to
stabilize currency and aid government finance

Early CBs were private and independent

Third wave of CBs turn of 20C to adhere to gold standard and
deal with financial stability, eg Federal Reserve, SNB
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Session II(continued)
Monetary History and the Monetary
Policy Framework

Classical CB policy , adhere to gold standard convertibility,
follow rules of the game, follow Bagehot’s rule to maintain
financial stability

20C CBs become concerned with the real economy, reflected
changes in political economy and in economic thinking

CB learning curve was steep in 20C, learning to steer between
internal and external stability , price stability and real economy
stability

Eg) Federal Reserve adhered to real bills doctrine and gold
standard. Great Depression consequence of real bills.
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Session II(continued)
Monetary History and the Monetary
Policy Framework

Fed and banks blamed for Great Depression . Leads to regulation
of financial system and Fed loses independence and is subservient
to the Treasury. Monetary policy becomes impotent in 30s and
40s.

Similar story in European countries

Fed regains independence within the government in 1951. Other
countries wait until1980s (exception Germany, Switzerland)

Bretton Woods – adjustable peg, gold dollar standard. Conflict
between internal and external goals. By mid 60s in US internal
goal of full employment wins, leads to inflation and end of gold
constraint. Great Inflation follows. Same story in Europe except
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Germany, Switzerland and Austria
Session II(continued)
Monetary History and the Monetary
Policy Framework

Great Inflation ends with tight money Volcker/ Thatcher 1979-80.
Return to price stability as key goal in mid 80s, stable nominal
anchor under fiat money

Inflation targeting ( explicit/ implicit) in early 90s. Case for price
level targeting.

Pattern of financial instability begins after deregulation in 70s .
Cycle of regulation/ financial innovation deregulation/ financial
innovation. Financial instability tied up with inflation instability

Pattern of asset booms and busts in environment of price stability.
Debate over whether CB acts proactively or retroactively.

Study of Central Bank history may distinguish between policy
regime based on the three goals.
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