Economic History Lunch Seminar

Eric Monnet (Paris School of Economics):"Central banks and the absorption of international shocks"

Abstract: We examine how central bank balance sheets react to international financial shocks and assess whether they can protect domestic financial markets from these shocks. Our study is based on newly collected monthly data from 22 central banks since 1890. Four results stand out. First, contrary to conventional wisdom, central banks do not only rely on foreign exchange intervention to tame international shocks, but actually buy more domestic assets to stabilize the money market rate. Second, the use of the central bank balance sheet to relax the constraints of fixed exchange rates has been the norm throughout history (with the exception of the European Monetary System). Third, until the 1970s, the textbook macroeconomic trilemma prevailed, so that central bank balance sheets did not need to respond to international shocks in the context of floating exchange rates or closed capital accounts. Fourth, the second financial globalization since the 1990s has created an unprecedented situation where central bank balance sheets are now called upon to absorb international shocks even in a floating exchange rate regime. The deepening of international financial markets has thus increased the reliance on the absorbing role of central bank balance sheets.

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