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Central banks and history: a troubled relationship

Barry Eichengreen

The Bank of England co-organised a ‘History and Policy Making Conference‘ in late 2020. This guest post by Barry Eichengreen, Professor of Economics and Political Science at the University of California Berkley, is based on material included in his keynote address at the conference.

Learning from history is hard. At central banks, it can be hard to draw policymakers’ attention to historical evidence. Even when historical analogies are at the forefront of their minds, the right analogies are not always applied in the right way. In fact, over-reliance on a small number of compelling historical case studies can lead to suboptimal decisions. Policymakers therefore need access to a wide portfolio of analogies. They must also cultivate an historical sensibility that is suspicious of simplification and alert to the differences – as well as the similarities – between ‘now’ and ‘then’.

The Bank of England is at the forefront of the movement to foster historical research on monetary and financial issues. It welcomes researchers to its archives, where, as part of a broader change in British records policy, they can consult materials from as recently as 20 years ago. It has commissioned histories of the Bank, of which Harold James’ ‘Making a Modern Central Bank‘ is the latest. Staff and academics have collaborated on the development of historical time series for the British economy; the fruits of their efforts are available on the Bank’s website. The Bank has researchers on staff who utilise historical evidence and methods when studying monetary and financial topics such as the operation of international banking and the incidence of credit controls.

Curiously, however, if one searches for mentions of history in the ‘Minutes of the Monetary Policy Committee’, one finds few. These tend to be along the lines of ‘The business-inventories-to-sales-ratio has fallen to an historically low level’, or ‘Inflation expectations have picked up to above their historical average’. These are references to very recent history. I looked closely at the minutes from 2008–09, during the Global Financial Crisis, when one might have expected to find references to earlier financial crises, phenomena with which the Bank as an institution has ample experience; interestingly, I didn’t find them. This is in contrast to the minutes of the Federal Open Market Committee of the U.S. Federal Reserve, where one finds multiple references to the Great Depression.

How then should we understand the Bank of England’s investment in history? One answer is that this attention to history is part of the Bank’s communications strategy. An effective monetary policy strategy requires communicating the central bank’s objectives, strategies and decision-making processes to financial market participants, politicians and the public. Central bank independence is viable only if accompanied by adequate accountability; and communicating its thinking allows the central bank to be held accountable in the court of public opinion. Describing how objectives, strategies and decision-making processes have been re-shaped by events helps outsiders to comprehend the central bank’s priorities. This includes explaining how the Bank’s current objectives and approaches differ from those of the past. This conveys a sense of how the Bank as an institution has evolved and how its actions are affected by the context in which it operates. 

But is history useful to the Bank of England beyond its contribution to communications? One answer is that research is an important function of a central bank, and knowledge of economic history makes for better research. The research function is richer and better informs policy insofar as it employs scholars with knowledge of earlier economic, monetary and financial events, and researchers with a historical sensibility. 

Generating historical information and analysis is one thing; how exactly policymakers should use it is another. Most obviously, there is the temptation to use history for analogical reasoning. As I have argued elsewhere, analogies are an instinctually appealing mode of reasoning for humans. There is a literature in cognitive science where it is argued that analogical reasoning is a central to human thinking. The use of analogy appears to develop spontaneously at a very young age among members of the human species. Most other primate species, in contrast, can’t be taught to recognise relational patterns, or can be so taught only with great difficulty. 

History, of course, is a rich source of analogies. Political scientists such as Richard Neustadt and Ernest May argue that policymakers resort to analogies especially during crises, when there is no time for deductive reasoning (for formal modeling of heretofore un-modelled circumstances). They point to the importance of the Munich analogy in President Harry Truman’s decision to go to war in South Korea, or to how the Battle of Dien Bien Phu informed John F. Kennedy’s decision to escalate the war in Vietnam. One of the leading books in this subfield is entitled, revealingly, ‘Analogies at War‘.

This observation leads to what might be called ‘the analogy problematique’. Analogical reasoning, like other forms of reasoning, is subject to misuse. Analogies can be invoked without testing them sufficiently – that is, without verifying the existence of similarities along the relevant dimensions. Decision makers rarely select the fittest candidate or candidates from a portfolio of analogies, tending to focus instead on one. They are excessively influenced by what Philip Zelikow refers to as ‘the searing analogy‘. For central bankers, more often than not, this is the Great Depression. As Ben Bernanke famously acknowledged at Milton Friedman’s 90th birthday celebration, ‘Regarding the Great Depression: you’re right, we did it. We’re very sorry. Thanks to you, we won’t do it again’. The problem being that searing analogies can divert attention from more relevant episodes and thus from important aspects of the current situation. They can serve as a set of blinders, in other words, as well as a set of spectacles (as argued in Eichengreen (2015)).

I am reminded of this each time an economic and financial crisis erupts, most recently in March of 2020, when I get calls from reporters. Typically, the questioner starts: ‘How does this crisis compare to the Great Depression?’ To which I typically answer: ‘It doesn’t compare’.  For example, if we want to contrast the Great Depression with the onset of the Covid-19 recession, then the starting point should be that the Depression was first and foremost a shock to aggregate demand, whereas the Covid recession started with a shock to aggregate supply. Just because output fell in both cases doesn’t mean that there is a useful analogy.

At which point my interlocutor responds, ‘OK, but if not the Great Depression, then what other episode is analogous?’ To which the relevant response might be: ‘Maybe there is no good analogy’. This response would be the appropriate if Covid-19 is unprecedented in important respects. 

These observations point to a slightly different use of history. History can be used to focus attention on what is distinctive about current circumstances. What is relevant is precisely what is not analogous with earlier historical episodes. History is useful for understanding how ‘this time is different’, to invoke the title of a well-known book. But accomplishing this requires marshaling a portfolio of historical analogies, and not just one, to return to an earlier point. It requires understanding what is distinctive about each episode. That’s where a historical sensibility, acquired through training or long experience, comes in.

Yet another way in which history can be useful for policy is as a parable. A parable is a simple didactic story that illustrates one or more instructive lessons or principles. Catherine Schenk has described how Fed Chair William McChesney Martin, in a controversial 1965 speech, invoked the 1920s as a parable illustrating the point that economic and financial stability should not be taken for granted. It is not clear that Martin took the analogy between the 1920s and 1960s seriously; there is no evidence that he had read his Friedman and Schwartz. But he saw a speech highlighting the similarities as useful for making his point.

Unfortunately, while parables are simple by construction, history is complex – as historians will be quick to tell you. This raises to danger that the parable does violence to the history by stripping away essential complexity. A parable can be useful because it conveys an important point. But it can mislead if this distillation crowds out deeper understanding of the actual event. 

At this point, economic history becomes a source of ‘stylized facts’. This is a term that my dissertation advisor, Bill Parker, actively despised. He never tired of reminding students that, for an historian, there is no such thing as a stylized fact. (Realising this is what Parker meant by possessing a historical sensibility.)  Fortunately, there is no shortage of prickly economic historians to prevent history from being distilled in this way.


Barry Eichengreen is Professor of Economics and Political Science at the University of California Berkley.

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