SUERF Policy Note, No 9

SUERF Policy Note Issue No 9, Dec 2016 Two turbulent centuries: Lessons from Austria’s monetary policy 1816 – 2016 By Ernest Gnan and Clemens Jobstˡ JEL-codes: E31, E42, E44, E58, F33, F65, N13, N14, N23 and N24. In 2016, the Oesterreichische Nationalbank celebrated its 200th anniversary. As part of a coordinated research project, the OeNB also issued a special double issue of its quarterly bulletin Monetary Policy & the Economy Q3-Q4/2016 covering a broad range of themes in two hundred years of central banking in Austria.2 The financial crisis of 2008 has upset several firmly-held beliefs about the role of central banks and the design of their policies. Central banks have changed their instruments and assumed new responsibilities. A new consensus, comparable to one prevalent during the Great Moderation, however, is yet to emerge. At this juncture, taking a look at the long-run evolution of central banking helps put changes (and continuities) into perspective and provides a fruitful way to reflect on the possible future of central banking. In the special issue of Monetary Policy & the Economy entitled “Two hundred years of central banking in Austria: selected topics” 15 authors analyse nine themes in the last 200 years of Austrian monetary history. Except one all articles address one particular aspect of central banking in a very-long run perspective: the determinants of inflation performance, the relationship to the government, the choice of an external anchor, responsibility for financial stability and lending of last resort, and last but not least, the central bank as provider of both cash and non-cash means of payment. We found the following themes to be of wider relevance to the readers of the SUERF Policy Note, also for future central bank and monetary policy design: ˡ Secretary General, SUERF, and Head of Economic Analysis Division, OeNB, [email protected]; Lead Economist, Economic Analysis Division, OeNB, and Research Affiliate, CEPR, [email protected]. This note reflects the personal views of the authors and should not be taken as official views of the Oesterreichische Nationalbank or the European System of Central Banks. The authors appreciate research assistance by Gerald Hubmann as well as helpful comments by Morten Balling, Frank Lierman and David Llewellyn. 2 Other publications include most notably two volumes on the institutional history of the Nationalbank (Antonowicz et al., 2016) and a history of central bank policy in Austria (Jobst and Kernbauer, 2016). For a complete overview of activities on the occasion of the OeNB’s 200th anniversary see https://oenb.at/en/About-Us/200th-anniversary-of- the-OeNB.html. www.suerf.org/policynotes SUERF Policy Note No 9 1 Two turbulent centuries: Lessons from Austria’s monetary policy, 1816-2016 While monetary stability was always recognized to prove such similar ability to ensure long-term as desirable by policy makers and central monetary stability, also during difficult times. bankers, it was repeatedly violated, notably in periods of war. Disinflation was knowingly Austria’s gradual transition from the demise of delayed for fear of social and political unrest. the Bretton Woods System towards the eventual The ultimately unavoidable currency reforms Deutsche Mark peg also offers an interesting had to be all the more drastic, fundamentally case study of how policy ambiguity can be damaging people’s trust in money and the state helpful in cautiously establishing consensus for a order in more general. The trade-off between stability-oriented policy among society and in short and long-term concerns, and the question keeping one-way market bets at bay. The road as to how to deal with exceptional circumstances towards EMU and the experience in the euro will always remain a challenge for central area so far in some respects also seems to fit this banking. notion. Deflation was not uncommon in Austria’s While the term “macro-prudential regulation monetary history. While in the 19th century, it and supervision” is quite recent, the use of tended to be supply-side driven and thus not a quantitative limits in order to contain (and, in matter of major concern, the demand-side, policy fact, also various subsidies and tax discounts in induced deflation during the Great Depression order to stimulate) credit growth was very was devastating for the Austrian economy and common in Austria between the 1950s and political system. This seems to fit with the more 1970s (as it was in other countries). More recent distinction between benign and malign generally, from the foundation of the central deflations. bank in 1816 onward, financial stability was seen as an integral part of monetary stability in Central bank independence has always been a a broader sense, and tools were designed accord- delicate political issue. It was hard to achieve ingly. A more integrated view of macroprudenti- and to preserve, and did not survive in times of al policies would seem useful also now. severe government financing needs, notably wars. The political stalemate between Austria As part of its responsibility for financial stability, and Hungary in the Austro-Hungarian monarchy the central bank recognized its function as a de facto increased the central bank’s lender of last resort early on. Its effectiveness independence, and the last decades before WW I was, however, at times limited by lack of trust in were a period of long-lasting monetary stability. central bank money, which was in turn due to This may bode well for the ECB within the euro excessive lending to government and/or area’s multi-country architecture. depleted foreign reserves. Also from this perspective, monetary and financial stability A formal definition of consumer price stability as need to be seen jointly in an integrated way. the monetary policy goal is a very recent development. Up until the Bretton Woods Cash was a major achievement of modern System, monetary policy relied on external monetary orders. Its wide-spread use originated anchors – metal standards or, later, exchange in its convenience of use. While its fiat nature rates. Except for war times, these anchors invited repeated abuse by the issuer(s), it worked remarkably well to preserve the value of continues to be the dominant means of payment money in a very long-term perspective, despite in Austria to this date, not least due to its good temporary disturbances. Modern monetary stability track record over recent decades. Path regimes without external anchors have a dependence and innovations which make cash comparatively short track record and have yet convenient and cost-effective may explain this. www.suerf.org/policynotes SUERF Policy Note No 9 2 Two turbulent centuries: Lessons from Austria’s monetary policy, 1816-2016 Austria’s monetary history also illustrates that extended periods of remarkable monetary stability, monetary policy cannot be fully understood by notably in the “long 19th century” up until WW I and the common macroeconomic perspective alone. since Austria’s accession to the EU in 1995 up until Monetary policy effectiveness rests crucially on now. The repeated periods of slight deflation in the incentives, information availability and the 19th century, notably in the first half of the 19th structure of markets in which the central bank century and in the post-Gru nderzeit last quarter of operates, and thus on microeconomic factors. the 19th century were “benign” in the sense that they Such more microeconomic perspectives seem were not accompanied by economic contractions, also crucial for current pending policy issues while the deflation of the early 1930s went hand in such as: the interplay between monetary, fiscal hand with a sharp economic contraction during the and structural policies; the challenge of optimal Great Depression. The (post) WW I and II periods financial sector regulation which finds a balance witnessed hyper or very high inflation, resulting from between creating appropriate incentives to a combination of a destruction of physical and human avoid moral hazard while not discouraging capital, large-scale monetary war financing, pent-up lending; and the challenge to avoid time inflation (WW II) and conscious late action by the inconsistent policy actions in the event of major central bank to address escalating inflation for fear of bank failures. social and political unrest (post WW I). In both instances, re-establishing monetary stability required A story of extremes: hyper-inflations drastic monetary reforms, i.e. far-reaching cancellations of financial assets, to eliminate and currency reforms, benign and monetary overhangs, which damaged peoples’ trust malign deflation, and long periods of in money and the state order more broadly. The remarkable monetary stability period of highest peace-time inflation occurred in the 1970s and 1980s, when efforts were made to cushion the negative output effects of supply-side oil price Austrian monetary history during 200 years must be shocks through expansionary demand policies. understood against the background of a dramatic political history. When the Nationalbank was founded Inflation volatility was high in the first half of the in 1816 it received the monopoly of banknote 19th century, reflecting frequent supply side price issuance for the entire Austrian Empire that at the shocks, and between the late 1960s and early 1980s, time formed the second largest European country in reflecting the oil price shocks and the associated stop terms of territory after Russia. When the Empire and go economic policies. Using frequency domain disintegrated in the wake of WW1, the Nationalbank analysis, the authors confirm a link between money found itself responsible for the currency of a small and inflation for long but not for business-cycle country in the middle of Europe. After Nazi-Germany frequencies, depending on the monetary regime. The occupied Austria in 1938, the Nationalbank ceased to authors cannot establish a stable empirical exist before being reestablished, when Austria was short-term Phillips curve relationship between liberated in 1945.

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