Monetary policy through the years

Central banks’ balance sheets – a historical perspective

In this paper, Ferguson et al. study how central banks have used their balance sheets over the past 400 years across 17 major economies. They use a new dataset that reconstructs central bank balance sheets using primary and secondary sources, on an annual basis, including the full breakdown of asset and liability components for many crises episodes. They find:

• Central banks’ utilization of their balance sheets started during the 17th and 18th centuries mostly during wars and revolutions.
• Central banks’ sensitivity to financial crises has risen sharply over the 20th century and, after the Great Depression, their providing liquidity support has increasingly become a systematic response to financial distress.
• Central bank liquidity support cushioned the economic effects of financial crises throughout the modern history of advanced economies. Using governor beliefs as a statistical instrument, the authors estimate that a central bank balance sheet expansion of at least +15% during the first or second year after a financial crisis outbreak bolsters real GDP by +21% cumulatively over the subsequent three years compared to the no-support counterfactual.

On average, this stabilization has been achieved without runaway inflation while crises without support were often followed by stagnant monetary aggregates and protracted deflation. In our data, liquidity support seems to have been effective in the form of lender-of-last-resort (LLR) action with Bagehot-style private asset purchases operations rather than through supporting public borrowing with intervention in government bond markets.

The Safety Net: Central Bank Balance Sheets and Financial Crises, 1587-2020
Authors: Niall Ferguson, Martin Kornejew, Paul Schmelzing, Moritz Schularick
From Hoover Institution, Stanford University, University of Bonn, Boston College, Sciences Po Paris

How to evaluate central bank performance during the last 150 years

In this paper, Barnichon and Mesters evaluate how central banks have reacted to the different shocks that hit the economy from a historical perspective. They have developed a methodology that looks at two impulse responses: (i) the impulse responses of the policy objectives to a (well-chosen) non-policy shock, and (ii) the same impulse responses but to a policy shock. They find that a large class of models and loss functions the distance to the optimal reaction, or Optimal Reaction Adjustment (ORA), can be computed from a simple regression in “impulse response space”: a regression of the impulse responses to the non-policy shock on the impulse responses to policy shocks.

The ORA measures by how much more or less a policy maker should have reacted in response to a given non-policy shock, and it provides a direct measure of policy performance conditional on a specific type of non-policy shock. Overall policy performance can then be assessed by measuring the ORAs for different types of non-policy shocks.

Evaluating Policy Institutions —150 Years of US Monetary Policy—
Authors: Régis Barnichon, Geert Mesters
From Federal Reserve Bank of San Francisco, Universitat Pompeu Fabra