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Up for grabs again

Central banking has undergone drastic changes during the last 100 years that are often unappreciated today. Before World War I, most central banks were partly or entirely privately owned. They were not expected to spur economic growth or smooth business cycles. Rather, they defined their goals more narrowly as adhering to the gold standard and earning modest profits for their shareholders in normal times. True, during wars they were expected to lend heavily to the government, temporarily suspending the gold standard if need be, and during financial crises they were expected to act as lenders of last resort to solvent but illiquid financial institutions. War between the major powers was viewed as improbable, though.

World War I struck like a thunderclap. Browse through old issues of the Commercial and Financial Chronicle, which in 1914 was the leading U.S. business publication, and you will see that in the month leading up to the war, European politics received little ink, as if the assassination of Archduke Franz Ferdinand were of no more world importance than the man who fired shots at the U.S. embassy in Sarajevo today. Then war came and within a week, more than half the world was embroiled in it, because Europe’s colonies were involved also.

By the war’s end, the central banks of the belligerent countries had created so much inflation to finance the war that returning to prewar exchange rates was either painful or impossible. Although the gold standard in principle remained the goal, the war had planted the idea that monetary policy could be “mobilized” in peacetime somewhat as it had been in wartime. The brief return of many countries to the gold standard in the late 1920s occurred in an intellectual climate where the standard no longer enjoyed its former unquestioned, and largely unquestioning, support. The Great Depression and World War II finished the job. By 1945, almost all central banks were government owned institutions whose primary goal was macroeconomic management, not profit seeking. There was a kind of gold standard — the Bretton Woods agreement had been signed and the signatories were working towards implementing it — but it was a gold standard in most cases hedged about by exchange controls, and without the depth of commitment of the pre-World War I gold standard. In the early 1970s that, too, ended.

As all readers who are at least middle-aged will remember, a generation of turbulence followed. Inflation in the rich countries in the 1970s, the Third World debt crisis of the 1980s, inflation in postcommunist countries and the emerging market financial crises of the 1990s. Finally, in the last decade, there were some quiet years, when it was plausible to think that the main practical problems of central banking been largely solved. Now it’s all up for grabs again.