July 6, 2022
Workshop on Monetary and Financial History: Day Two
In yesterday’s post, I discussed the first day of the Atlanta Fed’s two-day virtual workshop on monetary and financial history. In today’s post, I’ll discuss the workshop’s second day, which began with presentations by Maylis Avaro (University of Pennsylvania) and Caroline Fohlin (Emory University).
Avaro’s paper , coauthored with Vincent Bignon (Banque de France), examined the historical (19th-century) credit policies of the Banque de France using a comprehensive dataset of credits that the Banque extended during one year (1898). In its credit operations, the Banque attempted to offset regional economic shocks by providing directed credit to the affected regions. It provided credit only against collateral, and it intensely monitored counterparties, especially for riskiness of their business model. Econometric analyses show that the Banque tended to extend credit at branches experiencing regional shocks, but usually only to parties judged to be sufficiently prudent. This analysis also shows that the Banque favored banks over nonfinancial firms and existing over new counterparties. Avaro concluded by arguing that this historical example illustrates the potential benefits of central bank credit operations when appropriate risk management can limit moral hazard.
The discussant for this paper was Angela Redish (University of British Columbia). Redish argued that the credit operations documented in the paper were somewhat different from what might be expected in other lender-of-last-resort situations, in which market disruptions might hinder assessments of risk and impair the value of collateral. Redish also questioned why private banks did not lend against the same sorts of collateral as the Banque, suggesting that some of the Banque’s lending success might have been the result of its market power as the monopoly issuer of banknotes within France.
Fohlin’s presentation described a research program, undertaken with Stephanie Collet (Deutsche Bundesbank), to construct a comprehensive dataset of interwar German stock prices. Fohlin’s presentation focused on data from the 1920s. These data span a number of major disruptions to the German economy, including the 1921–23 hyperinflation, the 1927 stock market crash, and the rise of the Nazi party. Volatility of individual stock prices and bid-ask prices were high during this unsettled period. Despite this volatility, micro analysis of the data shows that the German stock market was surprisingly liquid for most of the sample, with buy orders typically exceeding sell orders. Another surprise was that shares of new companies were as liquid as those of existing companies. Market illiquidity increased during the late 1920s, however, in the wake of the 1927 stock market bubble and ensuing market crash.
The discussant was Eugene White (Rutgers University), who suggested that the data collected by the authors could be applied to a number of interesting research topics. For example, the data could provide additional perspective on the performance of the interwar stock market if its performance were contrasted with the pre-1913 market. A greater understanding of the institutional background of the market—for example, regulatory structure and stock voting rights—would also be useful. White also questioned how much the release from wartime capital controls in1919 was behind the apparent vitality of the 1920s market. Finally, White suggested that the authors investigate the impact of Reichsbank regulatory policy, margin requirements in particular, on market liquidity.
Looking back, and ahead
The fourth session of the workshop consisted of a panel discussion of the past and future of money. The panelists were François Velde (Federal Reserve Bank of Chicago), Gary Gorton (Yale University), and Marc Flandreau (University of Pennsylvania),
Velde’s presentation considered possible roles for central bank digital currencies (CBDC) in the context of historical examples of monetary innovation. Velde observed that central banks arose from earlier, coin-based monetary systems, to fill gaps in those systems, first through giro transfers (a type of payment transfer between banks) and later through circulating currency. Originally most central banks only dealt with large-value payments, and even today most central banks are not retail-oriented. That could change with CBDCs, Velde noted, especially if future CBDCs incorporate innovative features such as smart contracts, although the property rights of information collected on CBDC users will be a contentious policy issue. Another unresolved issue regarding CBDCs is their role with respect to private digital currencies. Velde argued that competition between public and private moneys could be beneficial. Velde concluded by noting the monetary innovations are often the product of accidents or strong underlying trends, rather than conscious policy choices.
Gorton’s presentation focused on new forms of private money and associated policy issues. Gorton argued that all private money inherently has the problem of information asymmetry and that the classic solution to this problem is to create money with a par value so that its value does not have to constantly be reassessed in market transactions. Typically, par money is debt that is backed by other debt. This solution creates another problem, Gorton argued, which is that debt-backed money can be subject to runs and sudden loss of value when confidence is lost in the money’s backing. Stablecoins—digital tokens that have safe asset backing—are susceptible to the same problems as paper-based forms of private money, as recent runs on stablecoins show. Gorton concluded by drawing on the history of paper currency to suggest that the only viable long-term solution to the run problem will be central bank monopoly of digital token issue.
Flandreau’s presentation considered the impact of monetary innovations on international currency competition. Flandreau rejected the “unipolar” and “multipolar” interpretations of monetary history literature (basically, a tendency to converge toward one or more dominant currencies), instead arguing that the true nature of monetary evolution has been one of currency competition regimes. As an example, he cited a currency competition regime that centered around the bill of exchange, an important international payment instrument from the 14th through the early 20th centuries. Major European currencies competed for international status within this regime by developing dense markets for bills of exchange. However, latecomers to this currency competition (Germany, Japan, and the United States) increased their competitiveness through new infrastructure, such as international branch banking, and new payment instruments, such as telegraphic transfers. These innovations supported the rise of the US dollar as an international currency when bills of exchange fell from use during the 1930s. Flandreau saw this history as illustrating the idea that currency regimes depend on their underlying financial infrastructure and monetary instruments.
The conference’s fifth session featured paper presentations by Sasha Indarte (University of Pennsylvania) and Marc Weidenmier (Chapman University). Indarte’s paper analyzed a dataset of sovereign bond defaults from 1869 to 1914, which was matched to a dataset of sovereign bond prices during the same period. Indarte described how a critical aspect of sovereign bond issue during this period was the reputation of the party underwriting the bond in the London financial markets. Econometric analyses show the presence of underwriter-related spillovers. More specifically, default of one sovereign bond issue typically depressed the prices of bonds with the same underwriter, after taking into account other observable factors. The reputation spillover effect is economically significant and evident for at least two years following a default. Indarte concluded by observing that this same pattern of underwriter spillover effects might be present in modern contexts such as syndicated lending.
Jonathan Rose (Federal Reserve Bank of Chicago) provided the discussion . Rose noted that the effect of underwriter reputation, while well documented in the paper, was perhaps more critical in historical than modern contexts (citing mortgage-backed securities as an example), due to the sovereign bonds’ lack of regulation or credit enhancement features. Rose also raised the possibility of self-selection in the data sample, with weaker bond issuers seeking out underwriters who were more willing to risk their reputations.
Weidenmier presented new data series of US industrial production in the decades surrounding the Civil War (1840–1900), taken from a recent paper coauthored with Joseph David (Vanguard Group). The data series uses hand-collected, city-level data and are separated by Northern and Southern states. The data show that growth in Northern-state industrial production was little affected by the war. Southern-state industrial production, on the other hand, fell precipitously during the war and did not return to prewar levels until about 1875. Capital-intensive industrial production in Southern states was especially slow to recover. However, rapid growth resumed in the 1880s, perhaps because of the resolution of uncertainty regarding investor property rights following the end of Reconstruction.
The discussant for this paper was Mark Carlson (Board of Governors), who noted that some of the regional differences documented in the paper might have been the result of the population’s westward expansion, which was more pronounced in the North. He also suggested that the quality of some of the immediate postwar data in the South might have been poor, possibly biasing statistical results. Those concerns aside, a striking feature of the data is that the North did not see a postwar contraction, as occurred in the United States after World War II. Finally, Carlson proposed that the observed regional differentials might be attributable to the disruption of the banking system that the South experienced during the Civil War and its immediate aftermath.
The conference’s final panel was a discussion of the evolution of the Fed’s mission and governance. The panelists were Sarah Binder (George Washington University), Lev Menand (Columbia University), and Ned Prescott (Federal Reserve Bank of Cleveland).
Binder began the panel with an analysis of the Fed’s political independence drawn from her recent book with Mark Spindel. Binder proposed that the conventional view of the Fed as an agency insulated from short-term political pressures is incorrect, arguing that this view is overly rooted in struggles to control inflation during the 1970s and 1980s. Moreover, it overlooks both the historical importance of financial crises in shaping the Fed and the partisan context in which the Fed operates. Under this view, the Fed and Congress display interdependence, the Fed gaining political support and the Congress gaining the Fed’s ability to quickly react in crises, as well as to absorb blame for unfavorable economic outcomes. Binder went on to argue that this interdependence has driven the structural evolution of the Fed, in the form of cycles whereby successive crises result in Congressional reforms of the Fed. Sensitivity of Fed policymakers to this cycle of reform has influenced many Fed policy decisions, Binder noted, its structural independence notwithstanding.
Menand’s presentation focused on the role of the Fed within the broader legal framework of the US monetary system. Although some legal scholars see the Fed as a “hodgepodge agency” with many unrelated functions, Menand argued that the Fed’s role is a coherent one within the US monetary tradition, which “outsources” money creation to independent entities, including chartered commercial banks but, since 1913, also the Fed. The structure of the Fed also resonates with the US tradition of geographic diffusion of banking, as well as the tradition of bank supervision. In addition, independence of the Fed from the executive branch coheres with the general US tradition of outsourcing the task of money creation. However, Menand proposed that more recently, the Fed has ventured beyond its traditional boundaries through its interactions with shadow banks, which are entities that issue deposit-like liabilities but lack bank charters. Menand concluded by arguing that Fed actions to support shadow banks during financial disruptions in 2008 and 2020 have eroded traditional political limits regarding what the Fed is expected to accomplish.
Prescott’s presentation focused on the evolution of the research function at the Reserve Banks, drawing on a recent paper coauthored with Michael Bordo. Prescott described how research was not emphasized at the Reserve Banks until the 1951 Treasury-Fed Accord, which granted the Federal Open Market Committee more independence in setting monetary policy. Prescott noted that during the 1950s and 1960s, this independence led to an increased emphasis on research, in part because more economists had become Reserve Bank presidents. During this period, the St. Louis Fed assumed the role of a “dissenting Reserve Bank,” articulating policy positions based on monetarist ideas. During the 1970s, research conducted at the Minneapolis Fed fostered new approaches to monetary policy that incorporated the concept of rational expectations. Later, ideas promoted by researchers at the Richmond Fed (policy transparency) and the Cleveland Fed (inflation targeting) also came to influence Fed policymaking. Prescott concluded with the observation that these historical examples illustrate the value of the Fed’s decentralized structure, in which alternative approaches to policy can be formulated and incorporated into the policy process.