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Liquidity Management and Central Bank Strength: Bank of England - - PowerPoint PPT Presentation

Apr 10, 2023 704 likes •1.06k views

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 :

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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

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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

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SLIDE 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

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SLIDE 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?

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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

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SLIDE 6

This Paper

1) Assessment of CB strength 2) Assessment of policy effectiveness 3) Epilogue and conclusions

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SLIDE 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)
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SLIDE 8

Assessing CB Strength

  • 150.000
  • 100.000
  • 50.000

50.000 100.000 150.000 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 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 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

Assets and Liabilities

Deposits Banknote Circulation Capital and Rest Securities Bullion

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Assessing CB Strength

  • 150.000
  • 100.000
  • 50.000

50.000 100.000 150.000 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 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 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

Assets and Liabilities

Deposits Banknote Circulation Capital and Rest Securities Bullion

Higly capitalized bank

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Stock Capital Banknote Circulation Bullion Reserve Total Balance 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%

Assessing CB Strength

Higly capitalized bank Select CB Balance Sheet Items as % of GDP (1909)

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Assessing CB Strength

  • 150.000
  • 100.000
  • 50.000

50.000 100.000 150.000 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 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 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

Assets and Liabilities

Deposits Banknote Circulation Capital and Rest Securities Bullion

Stable banknote circulation

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Stock Capital Banknote Circulation Bullion Reserve Total Balance 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%

Assessing CB Strength

Small banknote circulation Select CB Balance Sheet Items as % of GDP (1909)

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Assessing CB Strength

  • 150.000
  • 100.000
  • 50.000

50.000 100.000 150.000 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 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 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

Assets and Liabilities

Deposits Banknote Circulation Capital and Rest Securities Bullion

In relative terms, a large bullion reserve…

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Stock Capital Banknote Circulation Bullion Reserve Total Balance 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%

Assessing CB Strength

… in absolute terms, a small bullion reserve Select CB Balance Sheet Items as % of GDP (1909)

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Assessing CB Strength

  • 150.000
  • 100.000
  • 50.000

50.000 100.000 150.000 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 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 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

Assets and Liabilities

Deposits Banknote Circulation Capital and Rest Securities Bullion

Unstable deposits

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SLIDE 16

5.000 10.000 15.000 20.000 25.000 30.000 35.000 40.000 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 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 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

Deposits

Governm ent Private Bankers

Assessing CB Strength

Bank’s reserves determined exogenously (Goodhart 1972); unlike in previous periods (e.g. 1866), they do not increase during crises

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Assessing CB Strength

  • 150.000
  • 100.000
  • 50.000

50.000 100.000 150.000 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 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 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

Assets and Liabilities

Deposits Banknote Circulation Capital and Rest Securities Bullion

Unstable portfolio

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SLIDE 18

5.000 10.000 15.000 20.000 25.000 30.000 35.000 40.000 45.000 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 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 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

Securities

Governm ent Private Discounts & Advances

Assessing CB Strength

Unstable portfolio (discounts & advances)

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SLIDE 19

Stock Capital Banknote Circulation Bullion Reserve Total Balance 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%

Assessing CB Strength

A small CB Select CB Balance Sheet Items as % of GDP (1909)

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SLIDE 20

Assessing CB Strength

A small CB

4% 5% 6% 7% 8% 9% 1891 1892 1893 1894 1895 1896 1897 1898 1899 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909

Central Bank Assets to Total Banking System Assets

End of Year Mid- Dece mber

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SLIDE 21

50 100 150 200 250 300 Bank of England (31/12/1913) Midland Bank Lloyds Bank Westminster Bank Bank of England (17/12/1913) National Provincial Bank Barclays Bank Parr's Bank Union of London and Smiths Bank Capital and Counties Bank London Joint Stock Bank Banque de France (1909) Crédit Lyonnais Société Générale Comptoir National d'Escompte de Paris Reichsbank (1909) Deutsche Bank Dresdner Bank Disconto-Gesellschaft Bank für Handel und Industrie Société Générale de Belgique Banque Nationale de Belgique (1909) Oesterreichische-Ungarische… Credit-Anstalt National City Bank Guaranty Trust Co of New York

World's Top Commercial and Central Banks by Assets (1913)

Assessing CB Strength

A small CB UK FR DE BE AT US

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SLIDE 22

Assessing CB Strength

  • BoE’s weakness

Huge contingent assets from standing facility Limited room for expansion of liabilities

  • Attempts to reform after 1890 (Pressnell 1968)

BoE asks for permission to remunerate deposits (DENIED) BoE asks for introduction of reserve requirements (DENIED)

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SLIDE 23

Assessing CB Policy Effectiveness

Britain - Bank Britain - Market Germany - Bank Germany - Market France - Bank France - Market Netherlands - Bank Netherlands - Market Belgium - Bank Belgium - Market Austria - Bank Austria - Market Italy - Bank Italy - Market 0,30 0,40 0,50 0,60 0,70 0,80 0,90 1,00 1,10 1,20 1,30 2,00 2,50 3,00 3,50 4,00 4,50 5,00 5,50 Interest Rate Series: Standard Deviation Interest Rate Series: Average Level

1889-1910

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SLIDE 24

Assessing CB Policy Effectiveness

  • Discontent at interest rate volatility, triggering

macroeconomic instability (Palgrave 1903)

  • BoE unhappy with it
  • BoE tries to cap market rate volatility through

“unconventional” liquidity management strategies:

“Gold devices”: changing bid/ask prices of gold (Sayers 1936, Ugolini 2013) “Borrowing on Consols”: liquidity-absorbing OMOs (Hawtrey 1934, Sayers 1936, this paper)

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SLIDE 25

Assessing CB Policy Effectiveness

  • BoE lacks control over domestic interbank rates

(Bank rate “ineffective”)

  • To avoid excessive access to standing facility

(market “in Bank”) triggering Bank rate spikes, BoE acts preventively to prick credit expansion:

Secretly implements reverse repos (mostly on corporate, not gov’t securities) at very short term Triggers an inversion of the yield curve Impacts expectations on future rates Raises Bank rate to avoid access to standing facility

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Assessing CB Policy Effectiveness

0% 1% 2% 3% 4% 5% 6% 7% 8% 02/01/1889 10/07/1889 15/01/1890 23/07/1890 28/01/1891 05/08/1891 10/02/1892 17/08/1892 22/02/1893 30/08/1893 07/03/1894 12/09/1894 20/03/1895 25/09/1895 01/04/1896 07/10/1896 14/04/1897 20/10/1897 27/04/1898 02/11/1898 10/05/1899 15/11/1899 23/05/1900 28/11/1900 05/06/1901 11/12/1901 18/06/1902 24/12/1902 01/07/1903 06/01/1904 13/07/1904 18/01/1905 26/07/1905 31/01/1906 08/08/1906 13/02/1907 21/08/1907 26/02/1908 02/09/1908 10/03/1909 15/09/1909

The Interest Rate Corridor in London

OMOs Bank Rate Market Rate (3 Months) Commer cial Banks' Deposit Rate

BoE lacks control over interbank rates, implements OMOs while raising official rates

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SLIDE 27

Assessing CB Policy Effectiveness

  • 32 episodes of inversion of the yield curve in

1889-1910

  • Of these, 14 (on average, more intense) are

associated with Bank interventions

  • BoE aims at impacting market expectations:

Market perceives that inversions are generally associated with future rate increases (Peake 1923) Yet market does not unanimously acknowledge the Bank’s role in triggering inversions (Peake 1923)

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SLIDE 28

Assessing CB Policy Effectiveness

Intervention generally (but not systematically) effective

  • 6,00%
  • 4,00%
  • 2,00%

0,00% 2,00% 4,00% 6,00%

  • 15000
  • 10000
  • 5000

5000 10000 15000 Maximum Variation of the Interest Rate Maximum Amount of Bank of England Intervention

Overnight Rate

  • 6,00%
  • 4,00%
  • 2,00%

0,00% 2,00% 4,00% 6,00%

  • 15000 -10000
  • 5000

5000 10000 15000 Maximum Variation of the Interest Rate Maximum Amount of Bank of England Intervention

Three-Month Rate

1889-1910

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SLIDE 29

Assessing CB Policy Effectiveness

Intervention generally (but not systematically) effective

  • 3,00%
  • 2,00%
  • 1,00%

0,00% 1,00% 2,00% 3,00%

  • 4000
  • 2000

2000 4000 6000 One-Week Change in the Interest Rate Daily Variation of Bank's Borrowings

Overnight Rate

  • 3,00%
  • 2,00%
  • 1,00%

0,00% 1,00% 2,00% 3,00%

  • 4000
  • 2000

2000 4000 6000 One-Week Change in the Interest Rate Daily Variation of Bank's Borrowing

Three-Month Rate

1905-1910

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SLIDE 30

Assessing CB Policy Effectiveness

  • 80.000
  • 60.000
  • 40.000
  • 20.000

20.000 40.000 60.000 80.000 06.09.1905 20.09.1905 04.10.1905 18.10.1905 01.11.1905 15.11.1905 29.11.1905 13.12.1905 29.12.1905 12.01.1906 26.01.1906 09.02.1906 23.02.1906 09.03.1906 23.03.1906 06.04.1906 30.05.1906 14.06.1906 28.06.1906 21.08.1906 04.09.1906 18.09.1906 02.10.1906 16.10.1906 30.10.1906 13.11.1906 27.11.1906 11.12.1906 27.12.1906 10.01.1907 24.01.1907 07.02.1907 21.02.1907 22.10.1907 05.11.1907 16.10.1909 30.10.1909 13.11.1909 27.11.1909 11.12.1909 28.12.1909 11.01.1910

Balance Sheet Effects of OMOs

Private Deposits Bankers Deposits Advances London Discounts London Advances Country Discounts Country

The limits to intervention

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SLIDE 31

Epilogue

  • BoE’s capability of meeting all obligations

increasingly questioned

  • Debate on adequacy of gold reserves
  • Commercial banks expect BoE to default on

convertibility, accumulate gold directly

  • Banks trigger a run on the BoE in July 1914

(Keynes 1914; De Cecco 1974; Roberts 2013)

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SLIDE 32

Conclusions

  • BoE a core CB with strong commitment to

“sound” monetary policy

  • But BoE a weak CB with limited means to

pursue its targets

  • Poor quality of CB’s signals, lack of control
  • ver interbank rates
  • Inconsistencies lead to eventual implosion
  • Core and conservative CBs not immune from

policy sustainability issues

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SLIDE 33

Liquidity Management and Central Bank Strength: Bank of England Operations Reloaded, 1889-1910

Stefano Ugolini

Deutsche Bundesbank Workshop – Frankfurt am Main, July 8, 2015