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Liquidity Management and Central Bank Strength: Bank of England Operations Reloaded, 1889-1910 Stefano Ugolini Deutsche Bundesbank Workshop Frankfurt am Main, July 8, 2015 Motivation Pre-crisis consensus on pure interest rate policy :

  1. Liquidity Management and Central Bank Strength: Bank of England Operations Reloaded, 1889-1910 Stefano Ugolini Deutsche Bundesbank Workshop – Frankfurt am Main, July 8, 2015

  2. Motivation • Pre-crisis consensus on pure interest rate policy :  CB only sets signal (policy rate) and opportunity cost of reserves (deposit facility rate)  Interbank rate adjust to signal  If CB credible, no need for intervention  CB balance sheet size and composition only determined by autonomous factors

  3. Motivation • But this works under the hypothesis of no access to standing facilities (Borio and Disyatat 2010; Bindseil and Jablecki 2011):  If standing facilities are accessed, interest rate policy must be coupled with balance sheet policy  CB balance sheet size and composition not only determined by autonomous factors  Credibility depends not only on CB’s commitment, but also on the sustainability of monetary policy

  4. Motivation • Credibility and CB strength:  CB strength defined as capability to meet financial engagements. It depends on financial resources and contingent assets and liabilities (Stella 1997; Archer and Moser-Boehm 2013)  Empirical studies find a correlation between CB financial strength and monetary policy effectiveness (Klüh and Stella 2008; Adler, Castro, and Tovar 2012; Perera, Ralston, and Wickramanayake 2013)  Is this result peculiar to today?

  5. This Paper • Case study of pre-WW1 Britain:  Out-of-sample evidence  Core country  CB with very strong commitment to conservative monetary policy  Weak CB (limited ability to meet all engagements)  Poor policy effectiveness, macroeconomic instability

  6. This Paper 1) Assessment of CB strength 2) Assessment of policy effectiveness 3) Epilogue and conclusions

  7. Literature Review • Literature mostly concerned with the “rules of the game”: did BoE magnify gold flows?  Yes (Cunliffe Report 1918; Hawtrey 1934; Pippenger 1984; Dutton 1984; Davutyan and Parke 1995; Jeanne 1995…)  No (Bloomfield 1959; Goodhart 1972; De Cecco 1974; Giovannini 1986…) • But literature takes changes in CB balance sheet as deliberately implemented through OMOs • This is dubious (Sayers 1936; Moggridge 1984)

  8. -150.000 -100.000 100.000 150.000 -50.000 50.000 0 02/01/1889 12/06/1889 20/11/1889 30/04/1890 08/10/1890 18/03/1891 26/08/1891 03/02/1892 13/07/1892 21/12/1892 Assessing CB Strength 31/05/1893 08/11/1893 18/04/1894 26/09/1894 06/03/1895 14/08/1895 22/01/1896 01/07/1896 09/12/1896 19/05/1897 Assets and Liabilities 27/10/1897 06/04/1898 14/09/1898 22/02/1899 02/08/1899 10/01/1900 20/06/1900 28/11/1900 08/05/1901 16/10/1901 26/03/1902 03/09/1902 11/02/1903 22/07/1903 30/12/1903 08/06/1904 16/11/1904 26/04/1905 04/10/1905 14/03/1906 22/08/1906 30/01/1907 10/07/1907 18/12/1907 27/05/1908 04/11/1908 14/04/1909 22/09/1909 Bullion Securities Rest Capital and Circulation Banknote Deposits

  9. -150.000 -100.000 100.000 150.000 -50.000 50.000 0 02/01/1889 12/06/1889 20/11/1889 Higly capitalized bank 30/04/1890 08/10/1890 18/03/1891 26/08/1891 03/02/1892 13/07/1892 21/12/1892 Assessing CB Strength 31/05/1893 08/11/1893 18/04/1894 26/09/1894 06/03/1895 14/08/1895 22/01/1896 01/07/1896 09/12/1896 19/05/1897 Assets and Liabilities 27/10/1897 06/04/1898 14/09/1898 22/02/1899 02/08/1899 10/01/1900 20/06/1900 28/11/1900 08/05/1901 16/10/1901 26/03/1902 03/09/1902 11/02/1903 22/07/1903 30/12/1903 08/06/1904 16/11/1904 26/04/1905 04/10/1905 14/03/1906 22/08/1906 30/01/1907 10/07/1907 18/12/1907 27/05/1908 04/11/1908 14/04/1909 22/09/1909 Bullion Securities Rest Capital and Circulation Banknote Deposits

  10. Assessing CB Strength Select CB Balance Sheet Items as % of GDP (1909) Banknote Bullion Total Balance Stock Capital Circulation Reserve Sheet Britain (end-of-year) 0.72% 1.44% 1.91% 5.33% France 0.46% 12.88% 10.95% 15.59% Germany 0.41% 4.71% 2.06% 6.89% Austria-Hungary 0.83% 8.66% 6.42% 11.96% Italy 0.31% 7.66% 4.60% 10.93% Belgium 0.68% 11.56% 4.21% 14.75% Netherlands 1.06% 14.92% 7.38% 16.89% Switzerland 1.41% 7.40% 3.91% 9.94% Norway 1.44% 5.89% 3.82% 9.09% Britain (mid-December) 0.72% 1.41% 1.72% 4.54% Higly capitalized bank

  11. -150.000 -100.000 100.000 150.000 -50.000 50.000 0 02/01/1889 12/06/1889 20/11/1889 Stable banknote circulation 30/04/1890 08/10/1890 18/03/1891 26/08/1891 03/02/1892 13/07/1892 21/12/1892 Assessing CB Strength 31/05/1893 08/11/1893 18/04/1894 26/09/1894 06/03/1895 14/08/1895 22/01/1896 01/07/1896 09/12/1896 19/05/1897 Assets and Liabilities 27/10/1897 06/04/1898 14/09/1898 22/02/1899 02/08/1899 10/01/1900 20/06/1900 28/11/1900 08/05/1901 16/10/1901 26/03/1902 03/09/1902 11/02/1903 22/07/1903 30/12/1903 08/06/1904 16/11/1904 26/04/1905 04/10/1905 14/03/1906 22/08/1906 30/01/1907 10/07/1907 18/12/1907 27/05/1908 04/11/1908 14/04/1909 22/09/1909 Bullion Securities Rest Capital and Circulation Banknote Deposits

  12. Assessing CB Strength Select CB Balance Sheet Items as % of GDP (1909) Banknote Bullion Total Balance Stock Capital Circulation Reserve Sheet Britain (end-of-year) 0.72% 1.44% 1.91% 5.33% France 0.46% 12.88% 10.95% 15.59% Germany 0.41% 4.71% 2.06% 6.89% Austria-Hungary 0.83% 8.66% 6.42% 11.96% Italy 0.31% 7.66% 4.60% 10.93% Belgium 0.68% 11.56% 4.21% 14.75% Netherlands 1.06% 14.92% 7.38% 16.89% Switzerland 1.41% 7.40% 3.91% 9.94% Norway 1.44% 5.89% 3.82% 9.09% Britain (mid-December) 0.72% 1.41% 1.72% 4.54% Small banknote circulation

  13. -150.000 -100.000 100.000 150.000 -50.000 50.000 0 02/01/1889 12/06/1889 20/11/1889 In relative terms, a large bullion reserve… 30/04/1890 08/10/1890 18/03/1891 26/08/1891 03/02/1892 13/07/1892 21/12/1892 Assessing CB Strength 31/05/1893 08/11/1893 18/04/1894 26/09/1894 06/03/1895 14/08/1895 22/01/1896 01/07/1896 09/12/1896 19/05/1897 Assets and Liabilities 27/10/1897 06/04/1898 14/09/1898 22/02/1899 02/08/1899 10/01/1900 20/06/1900 28/11/1900 08/05/1901 16/10/1901 26/03/1902 03/09/1902 11/02/1903 22/07/1903 30/12/1903 08/06/1904 16/11/1904 26/04/1905 04/10/1905 14/03/1906 22/08/1906 30/01/1907 10/07/1907 18/12/1907 27/05/1908 04/11/1908 14/04/1909 22/09/1909 Bullion Securities Rest Capital and Circulation Banknote Deposits

  14. Assessing CB Strength Select CB Balance Sheet Items as % of GDP (1909) Banknote Bullion Total Balance Stock Capital Circulation Reserve Sheet Britain (end-of-year) 0.72% 1.44% 1.91% 5.33% France 0.46% 12.88% 10.95% 15.59% Germany 0.41% 4.71% 2.06% 6.89% Austria-Hungary 0.83% 8.66% 6.42% 11.96% Italy 0.31% 7.66% 4.60% 10.93% Belgium 0.68% 11.56% 4.21% 14.75% Netherlands 1.06% 14.92% 7.38% 16.89% Switzerland 1.41% 7.40% 3.91% 9.94% Norway 1.44% 5.89% 3.82% 9.09% Britain (mid-December) 0.72% 1.41% 1.72% 4.54% … in absolute terms, a small bullion reserve

  15. -150.000 -100.000 100.000 150.000 -50.000 50.000 0 02/01/1889 12/06/1889 20/11/1889 Unstable deposits 30/04/1890 08/10/1890 18/03/1891 26/08/1891 03/02/1892 13/07/1892 21/12/1892 Assessing CB Strength 31/05/1893 08/11/1893 18/04/1894 26/09/1894 06/03/1895 14/08/1895 22/01/1896 01/07/1896 09/12/1896 19/05/1897 Assets and Liabilities 27/10/1897 06/04/1898 14/09/1898 22/02/1899 02/08/1899 10/01/1900 20/06/1900 28/11/1900 08/05/1901 16/10/1901 26/03/1902 03/09/1902 11/02/1903 22/07/1903 30/12/1903 08/06/1904 16/11/1904 26/04/1905 04/10/1905 14/03/1906 22/08/1906 30/01/1907 10/07/1907 18/12/1907 27/05/1908 04/11/1908 14/04/1909 22/09/1909 Bullion Securities Rest Capital and Circulation Banknote Deposits

  16. 10.000 15.000 20.000 25.000 30.000 35.000 40.000 5.000 0 in previous periods (e.g. 1866), they do not increase during crises Bank’s reserves determined exogenously (Goodhart 1972); unlike 02/01/1889 12/06/1889 20/11/1889 30/04/1890 08/10/1890 18/03/1891 26/08/1891 03/02/1892 13/07/1892 21/12/1892 Assessing CB Strength 31/05/1893 08/11/1893 18/04/1894 26/09/1894 06/03/1895 14/08/1895 22/01/1896 01/07/1896 09/12/1896 19/05/1897 27/10/1897 06/04/1898 14/09/1898 Deposits 22/02/1899 02/08/1899 10/01/1900 20/06/1900 28/11/1900 08/05/1901 16/10/1901 26/03/1902 03/09/1902 11/02/1903 22/07/1903 30/12/1903 08/06/1904 16/11/1904 26/04/1905 04/10/1905 14/03/1906 22/08/1906 30/01/1907 10/07/1907 18/12/1907 27/05/1908 04/11/1908 14/04/1909 22/09/1909 Bankers Private ent Governm

  17. -150.000 -100.000 100.000 150.000 -50.000 50.000 0 02/01/1889 12/06/1889 20/11/1889 Unstable portfolio 30/04/1890 08/10/1890 18/03/1891 26/08/1891 03/02/1892 13/07/1892 21/12/1892 Assessing CB Strength 31/05/1893 08/11/1893 18/04/1894 26/09/1894 06/03/1895 14/08/1895 22/01/1896 01/07/1896 09/12/1896 19/05/1897 Assets and Liabilities 27/10/1897 06/04/1898 14/09/1898 22/02/1899 02/08/1899 10/01/1900 20/06/1900 28/11/1900 08/05/1901 16/10/1901 26/03/1902 03/09/1902 11/02/1903 22/07/1903 30/12/1903 08/06/1904 16/11/1904 26/04/1905 04/10/1905 14/03/1906 22/08/1906 30/01/1907 10/07/1907 18/12/1907 27/05/1908 04/11/1908 14/04/1909 22/09/1909 Bullion Securities Rest Capital and Circulation Banknote Deposits

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