Taming the Global Financial Cycle: Central Banks and the Sterilization of Capital Flows in the First Era of Globalization (1891-1913)

52 Pages Posted: 2 Aug 2019

See all articles by Guillaume Bazot

Guillaume Bazot

University Paris 8

Eric Monnet

Banque de France; Paris School of Economics (PSE)

Matthias Morys

York University

Date Written: July 2019

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: central banking, Federal Reserve System, gold standard, rules of the game, Sterilization, trilemma

JEL Classification: E42, E50, F30, F44, N10, N20

Suggested Citation

Bazot, Guillaume and Monnet, Eric and Morys, Matthias, Taming the Global Financial Cycle: Central Banks and the Sterilization of Capital Flows in the First Era of Globalization (1891-1913) (July 2019). CEPR Discussion Paper No. DP13895. Available at SSRN: https://ssrn.com/abstract=3428419

Guillaume Bazot (Contact Author)

University Paris 8 ( email )

2 rue de la Liberté
Paris, 93526
France

Eric Monnet

Banque de France ( email )

Paris
France

Paris School of Economics (PSE) ( email )

48 Boulevard Jourdan
Paris, 75014 75014
France

Matthias Morys

York University ( email )

4700 Keele Street
Toronto, M3J 1P3
Canada

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