Working Paper: CEPR ID: DP13895
Authors: Guillaume Bazot; Eric Monnet; Matthias Morys
Abstract: Are central banks able to isolate their domestic economy by offsetting the effects of foreign capital flows? We provide an answer for the First Age of Globalisation based on an exceptionally detailed and standardized database of monthly balance sheets of all central banks in the world (i.e. 21) over 1891-1913. Investigating the impact of a global interest rate shock on the exchange-rate, the interest rate and the central bank balance sheet, we find that not a single country played by the “rules of the game.” Core countries fully sterilized capital flows, while peripheral countries also relied on convertibility restrictions to avoid reserve losses. In line with the predictions of the trilemma, the exchange rate absorbed the shock fully in countries off the gold standard (floating exchange rate): the central bank's balance sheet and interest rate were not affected. In contrast, in the United States, a gold standard country without a central bank, the reaction of the money market rate was three times stronger than that of interest rates in countries with a central bank. Central banks’ balance sheets stood as a buffer between domestic economy and global financial markets.
Keywords: gold standard; sterilization; rules of the game; central banking; trilemma; federal reserve system
JEL Codes: N10; N20; E42; E50; F30; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Bank of England's interest rate increase (E52) | domestic rates in core countries (F29) |
| domestic loans increase (F34) | offset capital outflows (F32) |
| peripheral countries' restrictions on gold convertibility (F33) | manage reserve losses (G33) |
| floating exchange rates (F31) | absorb shocks without intervention (F35) |
| central banks serve as buffers against global financial cycles (F65) | manage domestic economic stability (E63) |