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The normality of extraordinary monetary reactions to huge real shocks


The normality of extraordinary monetary reactions to huge real shocks


In the space of a few days following the outbreak of the COVID-19 crisis, central banks ramped up their intervention spectacularly in order to calm the panic (panic (e.g. Ilzetzki 2020 for the UK). On 23 March 2020, the Fed pledged “unlimited” support not only to the public sector, but to the private sector as well. Commentators hailed these moves as “unprecedented”. But there are a number of historical precedents of bold central bank reactions to real economic shocks. In this column, I present three particularly interesting episodes.

1630: The Bank of Venice fights the bubonic plague

Venice was one of the most important financial centres in early-modern Europe. In 1587, it created its first public bank, the Banco della Piazza di Rialto, which was managed by a private concessionary. The government often lacked cash to make timely payments to its purveyors (typically merchant bankers), and in 1619 it began enabling them to transfer their state credits to third parties. Known as the Banco del Giro, this mechanism was originally intended as a small-scale provisional scheme to ease the liquidity concerns of merchant bankers (Ugolini 2017).

Shortly afterwards, Venice entered into the Thirty Years’ War (the 17th century equivalent of the 20th century’s two World Wars). Already weakened by the military effort, in 1630 Venice was hit by an epidemic of bubonic plague. It has been estimated that within the city of Venice, 46,000 people (33% of the population) died, while in some mainland Venetian towns, such as  Verona, the death toll exceeded 60%. This epidemic played a substantial role in triggering the decadence of the Italian economy (Alfani and Percoco 2019).

The Republic intervened quickly to preserve the social order. The state took charge of the maintenance of essential tasks, like the victualling of the population: it bought necessary goods from merchant bankers, and paid for them in money issued by the Banco del Giro – whose amount increased fivefold. The scale of the intervention had a clear impact on the value of such money: the exchange rate depreciated by more than 40% in 1630 (see Figure 1), when the government imposed a forced loan on the wealthy, whose income was used to reduce the quantity of money issued (Roberds and Velde 2014).

This dramatic episode triggered a long-lasting transformation of the Venetian financial system: the Banco del Giro’s money circulation crowded out the Banco della Piazza, which closed down in 1638. As a result, Venice unwillingly found itself experimenting with the first ever purely managed, state-issued money (Ugolini 2017). The experiment was successful: the Banco del Giro survived and helped Venice overcome a few more major shocks, until the Republic dissolved in 1797.

Figure 1 Foreign exchange rates of Venice on various European cities, 1620-1800

The normality of extraordinary monetary reactions to huge real shocks 2

Note: The thick line represents a common index.
Source: Roberds and Velde (2014).

1797: The Bank of England fights the French Revolution

The UK entered the French Wars (the 19th century equivalent of the World Wars) with a high level of public debt (around 150% of GDP). Still, in the early years of the conflict, the government managed to raise money relatively easily from financial markets (Antipa and Chamley 2019). The situation dramatically deteriorated when the First Coalition of anti-French powers collapsed in February 1797, leaving the UK alone in the military effort. While Ireland was on the brink of revolt (martial law would be imposed in March), on 22 February French troops landed on the Welsh coast. This was arguably the darkest hour for the UK: although the invaders were quickly defeated, the news sparked rumours of an imminent collapse of British rule. Depositors rushed to their banks to withdraw gold, and banks rushed to the Bank of England to beg for support. Because its bullion reserves were already dangerously low, leaving the Bank unable to lend without violating its convertibility requirements, the King authorised the Bank to suspend convertibility in order to help banks and calm the panic. This was the very moment when the term ‘lender of last resort’ was coined by Francis Baring (Ugolini 2017).

Contrary to received wisdom, the suspension of convertibility was not motivated by the need to monetise fiscal deficits, but by the need to help the private sector survive the extraordinary conditions created by the wars and the ensuing Continental blockade. From 1797 to 1815, central bank credit to the private sector increased more than threefold (even fourfold during the crisis of 1810), while central bank credit to the public sector remained roughly stable until as late as 1810 (see Figure 2). The private sector became ‘addicted’ to the central bank’s standing facility, which was then accessible by an impressively large number of financial and non-financial agents – a number never reached again (Clapham 1944, Bignon et al. 2012).

The UK financial system therefore underwent a major structural change, with the economic role of the central bank becoming much bigger than before. This change aroused harsh criticism, especially by the Bullionist lobby led by David Ricardo (Ugolini 2017). In view of such criticism, the Bank of England abruptly reversed its policy as soon as the wars ended: following 1815, central bank support to the private sector was decreased by a factor of six (see Figure 2), which paved the way for a quick return to convertibility, in 1821, but also generated a long and deep economic depression (Acworth 1925, Antipa and Chamley 2019).

Figure 2 Public and private assets held by the Bank of England, 1790-1825 (million pounds)

The normality of extraordinary monetary reactions to huge real shocks 3

Source: Antipa and Chamley (2019).

1914: The Bank of England fights the breakdown of international payments

On 28 July 1914, Austria-Hungary declared war on Serbia, and the entire global economy started to lock down in anticipation of an oncoming world war. The international payment system broke down: it became impossible for creditors to recover their overseas credits. At the time, London was the world’s financial centre and City banks were owed huge amounts of short-term funds from every corner of the globe (Accominotti et al 2019). The freeze of payments meant that the large (and highly leveraged) foreign-oriented share of the UK banking sector suddenly found itself on the brink of default.

The Bank of England stood ready to support the financial sector, but in order not to violate its convertibility requirements, it asked domestic banks not to withdraw gold from the Bank. Domestic banks did not withdraw, but refused to pay in gold to their customers and redirected them to the Bank of England. This spectacular coordination failure put the Bank in the same situation it faced in February 1797. In order to allow it to extend support to the financial sector, the government suspended convertibility on 31 July (Roberts 2013, Ugolini 2016).

Even more than during the French Wars, the suspension of convertibility was not used to monetise fiscal deficits during WWI. In the weeks following 31 July, the Bank increased its standing facility loans (‘discounts and advances’) by a factor of ten and its open market operations on corporate assets (‘private securities’) by a factor of three, which made the total size of its balance sheet increase almost threefold. The Bank’s portfolio of government debt also tripled, and then remained more or less stable (see Figure 3).

As had been the case one century before, the economic role of the central bank expanded significantly to keep the private sector afloat. But this time, support was focused on only a limited number of financial intermediaries, and was not discontinued after the conflict ended: unlike the post-1815 period, after 1918 the structural transformation of the UK financial system became a permanent one (see Figure 3).

Figure 3 Evolution of the Bank of England’s balance sheet, 1905-1925 (million pounds)

The normality of extraordinary monetary reactions to huge real shocks 4

Source: Author’s computations of Huang and Thomas (2016).


These three historical episodes provide a number of insights. First, they confirm the feeling that the financial sector is the ‘canary in the coalmine’ of real economic shocks. It is therefore not surprising that, in such moments, monetary authorities focus on supporting the financial sector in particular (and the private sector in general) rather than on buying government debt. In the event of major crises threatening the economic and social order, it is normal to see the role of the state dramatically increase, as the private sector looks to the state for insurance against non-insurable risk.

Thus, history suggests that extraordinary monetary reactions to huge real shocks are not exceptional per se. However, such reactions imply major structural transformations of the economic system. Getting rid of that system too hastily might not be a good idea. What should concern us is less the current intervention than a future escape from it. Finding the right ‘exit’ strategy tomorrow might be a harder task than finding the right ‘entry’ today.


Accominotti, O, D Lucena-Piquero and S Ugolini (2019), “The origination and distribution of money market instruments: sterling bills of exchange during the first globalisation”, CEPR DP 14058.

Acworth, AW (1925), Financial reconstruction in England 1815-1822, King & Son.

Alfani, G and M Percoco (2019), “Plague and long‐term development: the lasting effects of the 1629-30 epidemic on the Italian cities”, Economic History Review 72(4).

Antipa, P and C Chamley (2019), “Regimes of fiscal and monetary policy in England during the French Wars 1793-1821”, Boston University Department of Economics WP 327.

Bignon, V, M Flandreau and S Ugolini (2012), “Bagehot for beginners: the making of lender‐of‐last‐resort operations in the mid‐nineteenth century”, Economic History Review 65(2).

Clapham, JH (1944), The Bank of England: a history, volume II, Cambridge University Press.

Huang, H and R Thomas (2016), “The weekly balance sheet of the Bank of England 1844-2006”, OBRA dataset, Bank of England.

Ilzetzki, E (2020), “COVID-19: The economic policy response”, VoxEU.org, 28 March.

Roberds, W and FR Velde (2014), “Early public banks”, Federal Reserve Bank of Chicago WP 2014-03.

Roberts, R (2013), Saving the City: the great financial crisis of 1914, Oxford University Press.

Ugolini, S (2016), “Liquidity management and central bank strength: Bank of England operations reloaded 1889-1910”, Norges Bank WP 10/2016.

Ugolini, S (2017), The evolution of central banking: theory and history, Palgrave Macmillan.

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