Central banks: Evolution and innovation in historical perspective

Michael Bordo and Pierre Siklos have a shorter piece based on their longer research paper

The role of central banks in monetary policy and financial stability has changed radically over time. This examines the similarities and idiosyncrasies of ten central banks, and also considers how inflation might have looked had the central banks been around earlier, or had they adopted different strategies. While important differences between the narrative and statistical analyses of crises indicate that neither is sufficient on its own, small open economies appear to do comparatively well across the various crisis conditions, and inflation is almost always higher in the absence of an inflation target.

Hmm.

I was particularly interested in the results reported of Canada. There is this research which suggests how Canada had a stable financial system even before it had a central bank unlike other countries like US. Canada is also seen as a good example of free banking by its proponents.

What is interesting is how Canada without a central bank does well in things like inflation etc.:

Another illustration comes from counterfactual experiments. The basic premise of our counterfactuals is that there exist common factors that drive economic variables of interest, whether or not there is some treatment or intervention (Hsaio et al. 2012). Therefore, we can use information in the cross-section of inflation and real economic growth performance in countries that had a central bank, to ask how these two variables would have behaved had a central bank existed in a country that did not have one over the same period. We also use the Hsiao et al. (2012) approach to ask about macroeconomic performance if targeting had not been adopted.

Figures 1 and 2 display some of the counterfactuals. Figure 1 plots what inflation would have been like if the Swiss National Bank (middle), the US Federal Reserve (top), and the Bank of Canada (bottom) had been in existence before they were actually created. The smallest impact from the late introduction of central banking is observed for Canada. The observed and counterfactual lines are almost on top of each other. Thanks to the Finance Act of 1907, Canada arguably had a quasi-central bank before the Bank of Canada’s creation. In the case of Switzerland, inflation would have been not much different, on average, but considerably less volatile. Finally, in the US case, it is difficult to see any impact on inflation and inflation volatility had the Fed been in place in 1870. It should be pointed out that the raison d’être of the Fed lies in the search for financial stability, not inflation stability, and the series of financial crises that hit the US throughout the period shown testifies to the real problem with the monetary regime in the US.

Figure 2 considers the inflation consequences of inflation targeting. We ask what inflation and growth would have been if Canada (1991), Sweden (1993), and the UK (1992) had not adopted an inflation-targeting strategy (adoption years in parenthesis). The US, Japan, and Switzerland did not adopt inflation targeting, so these economies act as the controls in estimating the treatment effect of the strategy. We define the treatment period as the period since Bretton Woods until inflation targeting is adopted. It is immediately clear that inflation is almost always higher in the absence of an inflation target. Other than for Canada, differences between observed and counterfactual inflation rates show that the improvement in inflation performance is considerable.  For real economic growth, the evidence is more mixed with real economic growth lower under inflation targeting than in the counterfactual case.

Interesting bit. Should read the full paper for more details.

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