1.1 Introduction

Central banks are ubiquitous. Of the 195 sovereign states in the world today, 185 have delegated money issuance, monetary policy, oversight of the payment system, and lender-of-last-resort functions to specialized institutions known as central banks.Footnote ¹ Their pronouncements make headlines. These send tremors through money and asset markets, whose reaction central banks seek to channel using forward guidance and other communication. Ever-growing lists of their functions have entered college textbooks, as have tales of their exploits in helping countries navigate global financial shoals.

Such has not always been the case. A century ago, nearly two-thirds of the world’s sovereign states lacked a central bank (Figure 1.1). Central banking institutions then in existence commanded less authority. Their functions were circumscribed, their mandates ambiguous, their allegiances divided between multiple roles as commercial banks and appendages to the Treasury.

Figure 1.1 Sovereign states and central banks, 1820–2020

Source: See Appendix.

The key period of transition was the 1920s and 1930s. Between 1919 and 1939, twenty-eight new central banks were set up, most in what are now called emerging markets and developing economies. The studies collected in this volume examine the origins and early operation of these banks.Footnote ²

While an extensive literature documents the historical development of central banking in the now-advanced economies, the historical literature on central banking in emerging and developing countries, then and now, is more limited.Footnote ³ This imbalance deserves correction. Creating a central bank was seen as a key step in the process of modernization in late-developing economies. It was a step toward putting economic policy on a sound and stable footing and integrating emerging economies into the global system.

No sooner had the ink of newly drafted central bank statutes dried than the Great Depression swept across economies and political systems, putting new institutions to the test. Few interwar central banks successfully met the challenge. As a result of the political reaction to this failure, central banks became key agents in the Polanyian transition from the unfettered market system of the nineteenth century to the managed economy of the twentieth. In 1944, Karl Polanyi argued that the nineteenth-century combination of laissez-faire capitalism, unregulated labour markets, and the gold standard contained within it the seeds of this reaction, as popular opinion turned against the instability and inhumanity of market mechanisms (Polanyi, Reference Polanyi1944). New central banks had been established in the 1920s in an effort to temper the operation of this system. When they fell short (Schenk and Straumann, Reference Schenk, Straumann, Bordo, Eitrheim, Flandreau and Qvigstad2016), the economic and political crisis of the 1930s brought a Polanyian reaction. Private banks of issue were nationalized. Central banks were enlisted in managing the economy in cooperation with other branches of government. This set the stage for their role in supporting import substitution in Latin America and central planning in Eastern Europe during and after the Second World War. The newly established central banks of the 1920s and 1930s thus were integrally involved in the pivotal economic developments of the mid-twentieth century.

The ideas underpinning both the spread of central banking and the subsequent reaction are introduced in Chapter 2. Chapters 3 and 4 then focus on the role of the League of Nations and the Bank of International Settlements. These two organizations promulgated international standards for the structure and conduct of central banking (best practice, if you will) and sought to foster international cooperation amongst these newly created monetary institutions. Part II of the volume turns to eight country studies and two chapters of greater geographical ambition, one on Latin America and one on the British Dominions. All chapters nevertheless provide readers with the necessary political and economic background before tackling the key questions that run through the entire volume. Under what circumstances was each new bank established? What was the role of domestic and international players and how did they impact the structure, mandate, and powers of the resulting institutions? The authors are careful to distinguish de facto and de jure independence, as well as compliance (or otherwise) with the so-called rules of the game, which extended beyond the rules and regulations associated with the operation of the gold standard. All country studies discuss the impact of the Great Depression: the specific challenges to each economy, the monetary policy response, the extent to which policy was conditioned by each bank’s recent past, but also how it affected its future, not least by influencing the speed of economic recovery.

1.2 The Interwar Wave of New Central Banks

If not the father of all things, war was certainly the father of many of the new central banks of the 1920s. This was true of new states that emerged from the dissolution of the Habsburg, Ottoman, and Russian empires. It was equally true elsewhere, however, as old monetary arrangements were swept away and new banks were established.Footnote ⁴

Table 1.1 lists, in chronological order, the twenty-eight new central banks established between 1919 and 1939. Most of these institutions received statutory independence and a mandate to defend the value of the currency in terms of gold or gold-convertible foreign exchange.Footnote ⁵ As Harold James explains in Chapter 2, with extensive references to German experience, independence was designed to mitigate risks of fiscal and financial dominance that had become apparent with wartime and post-war inflation.Footnote ⁶ This, in a nutshell, was the argument behind the interwar drive to establish new central banks, and why most were established with the primary objective of averting inflation and maintaining the gold standard.

This mantra gained broad international currency, not least through the efforts of a network of central bankers, financiers, civil servants, and academics (Meyer, Reference Meyer1970; Schuker, Reference Schuker and Flandreau2003; Marcussen, Reference Marcussen2005). With missionary zeal the Bank of England encouraged the establishment of overseas clones of itself (Sayers, Reference Sayers1976: 201). Otto Niemeyer, senior Treasury official turned Bank adviser, was dispatched as money doctor to administer the appropriate medicine. Eager to check this British imperialism, the Banque de France launched missions to Romania and Poland.Footnote ⁷ The governor of the Federal Reserve Bank of New York, Benjamin Strong, shared Norman’s suspicion of politicians and his vision of a global network of cooperating central banks (Chandler, Reference Chandler1958: 281–285) and for his part encouraged American money doctors to spread the gospel. The most prominent American money doctor, Edwin Kemmerer, advanced this vision of central banking in Latin America and elsewhere on behalf of New York financial circles (Seidel, Reference Seidel1972; Drake, Reference Drake1989; Eichengreen, Reference Eichengreen, Calvo, Findlay, Kouri, de Macedo and Drake1989; Helleiner, Reference Helleiner2009).

Multilateral institutions such as the League of Nations also helped to disseminate new monetary ideology. Patricia Clavin (Chapter 3) explains how new ideas about central banking dovetailed with the League’s desire to limit state agency and relegate policy decisions to an international, rules-based depoliticized sphere. Intergovernmental conferences in Brussels in 1920 (under the League’s auspices) and Genoa in 1922 called on governments to return to the gold standard and establish central banks free of political control and open to cooperation. An Economic and Financial Organization (EFO) was set up within the League to gather intelligence and provide advice on economic and financial matters, including those related to central banking. Its representatives emphasized fiscal prudence, currency reform, and central bank independence, where the latter would be guaranteed by a statutory commitment to gold convertibility, limits on lending to the public sector, and a cap on state ownership.Footnote ⁸

Although the EFO projected itself as impartial and multilateral, it was close to London and the Bank of England in practice (Péteri, Reference Péteri1992). Its head, Arthur Salter, was British and had a collegial relationship with Norman. The US decision not to join the League tilted its scales toward London – much to the chagrin of the French, who remained suspicious of the League’s activities. These political tensions pushed central bankers away from the League and towards the Bank for International Settlements (BIS), which opened its doors in 1930 as a discreet venue for central bank cooperation away from meddlesome politicians (Toniolo, Reference Toniolo2005). As Piet Clement shows in Chapter 4, the vision behind the new organization extended far beyond the management of German reparations to functions previously performed by the League and that would later be entrusted to the Bretton Woods institutions.

1.3 Stabilization and Conditionality

New central banks were often set up in the effort to attract foreign capital. Bankers preferred lending to countries with a central bank on the gold standard. Hence developing countries eager to attract foreign capital could not afford to ignore their doctors’ prescriptions. Surveying Latin America for this volume (Chapter 12), Flores Zendejas and Nodari find no causal relationship between past macroeconomic performance and the establishment of new central banks; what mattered instead was the desire to attract foreign capital, which setting up a central bank promised to fulfil.

Similar considerations informed policy in Europe’s war-ravaged economies. With a trade surplus and no hyperinflation, policymakers in Czechoslovakia felt little pressure to tie their hands. But faced with the prospect of being excluded from international financial markets, they were coaxed into setting up a central bank, as Jakub Kunert explains in Chapter 8. In Chapter 11, Şevket Pamuk similarly describes how Turkish officials seeking to attract foreign investment invited foreign advisers, who paved the way for a new central bank in 1930.

Conditionality was strongest in supervised stabilizations. The League of Nations organized a string of programmes in the 1920s, four of which are covered by Hans Kernbauer (Austria, Chapter 5), Györgi Péteri (Hungary, Chapter 6), Andreas Kakridis (Greece, Chapter 9), and Roumen Avramov (Bulgaria, Chapter 10).Footnote ⁹ Austria was the first country to accept League assistance and submit to foreign control; this took the form of the appointment of a foreign commissioner in charge of fiscal policy and a foreign adviser to the new Austrian National Bank. The Austrian model was then exported to Hungary and Estonia. While Czechoslovakia and Poland also negotiated with Geneva, both ultimately rejected the League’s terms. Bulgaria and Greece were last to stabilize with the League’s assistance, their reforms tied to loans for refugee resettlement.

But conditionality was not unique to the League. As Cecylia Leszczyńska shows in Chapter 7, similar conditions underpinned Poland’s second stabilization in 1927, which was backed by the Federal Bank of New York and Banque de France and came on the heels of a Kemmerer mission. The abortive attempt by the BIS to stabilize the Spanish peseta in 1930, described by Clement, was taken from the same playbook.

Stabilization programmes, whether bilateral or multilateral, combined conditionality with external supervision. If independent central banks were meant to lend credibility to monetary policy, foreign enforcement was designed to enhance the credibility of stabilization and encourage fiscal and monetary rectitude.Footnote ¹⁰ Stabilization programmes could be painful and controversial. Political reaction was strong in Austria, for example, where stringent financial terms combined with heavy-handed intervention in the country’s relations with Germany; further, the role of international banks in the process fuelled antisemitism. In Hungary, the peg to sterling precipitated a painful Sanierungskrise in 1924–5; by 1926 an exasperated senior economist at the Hungarian National Bank complained to the League’s appointee, Harry Siepmann, that it might have been easier ‘to just gas Hungary with cyanide’ (see Péteri, Section 6.4). In Greece, controversies around stabilization toppled the coalition government, and calls for the abolition of the Bank of Greece persisted into the 1930s. In many ways, interwar adjustment programmes anticipated the post-1945 activities of the International Monetary Fund (IMF), in both their allegedly apolitical design and the political reaction they provoked.

A problem was the ‘one size fits all’ approach to stabilization and central bank design. Plans for new institutions derived from the experience of advanced countries were often ‘impracticable or even irrelevant’ to the problems of emerging markets.Footnote ¹¹ As several chapters explain, shallow markets, combined with prohibitions on open-market operations aimed at preventing the indirect financing of public expenditure, limited the ability of central banks to control the money supply. The problem could be exacerbated by conflicts between the bank of issue and commercial banks (for example in New Zealand, Australia, and Argentina, among others) that previously possessed limited central banking powers. Such conflicts were acute when the new institution was not the sole treasurer to the state (as in Greece, Hungary, or Czechoslovakia). John Singleton calls central banks in this position ‘banks in waiting’. He attributes their weakness to money doctors who, eager to bind emerging markets to the gold standard, paid inadequate attention to the capacity of new central banks to provide services to their host governments and economies.Footnote ¹²

Did countries seeking to tap international capital markets have no choice but to adopt the model forced upon them? ‘Beggars cannot be choosers’ was Siepmann’s reaction to questions about the design of Hungary’s stabilization programme (Péteri, Section 6.3). His colleague in Greece, Horace Finlayson, noticed locals’ negative reaction to externally guided banking reform – how this reform was received with a mixture of suspicion and hostility. The new central bank was ‘nobody’s child’, an orphan placed on the country’s doorstep by foreign advisers. Questions of parenthood, or lack of programme ‘ownership’, as this problem is known in the literature on IMF adjustment programmes (James, Reference James and Flandreau2003), arose in several countries covered in this volume.

At the same time, external enforcement could be welcomed as a way of deflecting political fallout from reforms that domestic elites recognized as necessary but unpopular. This argument, made by Kernbauer (Chapter 5) for Austria, is implicit in a number of other instances described in these pages.Footnote ¹³ Foreigners, in addition to serving as convenient scapegoats, were instruments for settling domestic distributional conflicts. Domestic interest groups and foreign advisers, finding themselves in the same trenches, formed alliances. In Greece, for example, commercial banks were keen to use League of Nations advisers in support of their campaign to rid themselves of unprofitable state debt.

Sometimes, domestic resistance could be effective in checking foreign interference. Although Santaella (Reference Santaella1993) cites the absence of a single occasion when League of Nations’ advisers used their veto power as evidence of tough external enforcement (knowing that ambitious fiscal initiatives would be vetoed, no government dared implement them), this could equally be taken as evidence of the opposite. The correspondence between Niemeyer and Horace Finlayson, the British consultant charged with monitoring the Greek agreement, reveals a constant tug of war between Athens, London, and Geneva, sometimes resulting in the Bank of England and League of Nations having to agree to uncomfortable concessions. The ‘sneaking nationalization’ of Hungarian monetary management, over the objections of foreign advisers, is another example of how those responsible for the operation of these new institutions were sometimes able to deviate from their operational guidelines. In Bulgaria, domestic political opposition to privatizing the central bank, as advocated by foreign advisers, led to its indefinite postponement. Similarly, the Austrian National Bank systematically ignored its foreign advisers when providing liquidity to struggling banks.

1.4 Institutional Convergence?

By the late 1930s, central banks were operating in two-thirds of sovereign states, up from one-third in 1920 (Figure 1.1). Still, this appearance of institutional convergence masked the persistence of very different visions of central banking (Singleton, Reference Singleton2011: 58). If the League of Nations and leading central bankers envisioned an international network of cooperating banks tied to a liberal economic order, many new institutions were set up with nationalist and statist objectives (Helleiner, Reference Helleiner2003: 152).Footnote ¹⁴ Publics and politicians saw their central banks as symbols of national sovereignty. This was true of European successor states but also, for example, of Turkey, where money issue was wrested from the foreign-owned Imperial Ottoman Bank, marking the Republic’s break with the Ottoman past.Footnote ¹⁵ Inasmuch as new central banks were meant to attract foreign capital and investment, policymakers saw them as instruments of activist intervention rather than as constraints on government.

The tension between these visions is evident, for example, in the case of Britain and its empire. As Singleton explains in Chapter 13, by encouraging new banks of issue, London hoped to insulate monetary management from local political control and keep it within sterling’s orbit. The Dominions, by contrast, saw their new banks as a first step towards financial autonomy and active policy. Given this conflict over the meaning of independence, both sides risked disappointment.

But the struggle was not just between the metropolitan centre and colony but also within the metropolitan bureaucracy itself. G. Balachandran (Chapter 14) describes how early controversies surrounding the establishment of an Indian central bank reflected a power struggle between the Bank of England and the India Office. Both agreed on the importance of keeping Indians out of monetary affairs. But whereas the India Office insisted on direct control, Norman wanted policy in the hands of an institution free from the India Office’s political interference, but allied with the Bank of England. Decisions were postponed until the deflationary crisis of the 1930s made further delay untenable. India then became the first colony with its own central bank. But any illusions as to the true power of the new institution were dispelled when the India Office replaced the governor with a civil servant and in 1938 overruled a decision to devalue the rupee.

Colonialism distinguishes India’s case but also invites us, more generally, to think differently about central banks. One way or another, the new institutions were designed to remove management of monetary affairs from the domestic political arena at the very time when the latter was becoming more representative. Extension of the franchise, the rise of labour politics, and the growth of social spending after the First World War rendered governments more likely to prioritize employment over gold convertibility. As one money doctor put it: ‘the trend of political evolution the world over […] is in a direction which makes it less safe to entrust governments with the management of currencies than it may have been in pre-war days.’Footnote ¹⁶

If delegation to a technocratic body was meant to contain this problem, the results could be disappointing. The hope that political problems could be bypassed by institutional fiat proved an illusion. As several chapters reveal, the very process of de-politicization was political, not only in its motives, but also in its distributional consequences.

1.5 The Great Depression in Developing Economies – A Policy Dilemma

Many emerging markets and developing countries ran current account deficits in the 1920s, financing them with foreign – mainly US – capital.Footnote ¹⁷ After 1928, when stock market volatility and a shift in monetary policy brought US capital exports to a halt, debtors were forced to retrench. Countries reliant on US capital, such as Germany and Poland, slipped into recession even before the United States. Next came the collapse in commodity prices, precipitated by shrinking demand and dumping of supplies. Countries like Hungary, Poland, Bulgaria, Argentina, Australia, and Brazil, who specialized in agricultural exports, faced deteriorating terms of trade, falling incomes, and balance of payments difficulties. By 1931, most developing countries – including those that stabilized under League of Nations tutelage – were having trouble keeping current on their foreign debts. As capital- and commodity-market shocks compounded one another, the recession deepened and spread.

Deflation especially strained debtors, whose liabilities increased in real terms.Footnote ¹⁸ The pressure shifted to banks, and countries with weak financial systems experienced banking crises (Bernanke and James, Reference Bernanke, James and Hubbard1991). Emerging markets were vulnerable to these disturbances, especially in countries where banks financed long-term assets (for example loans and equity) with short-term foreign liabilities. When foreign capital fled, depositors followed, and banking crises morphed into currency crises.

In Europe’s successor states, the banks never fully recovered from hyperinflation or adjusted their business to new national borders. Austria’s crisis in May 1931 is the best known example, not least because it spread to Hungary and – once compounded by trouble in Germany – helped to push sterling off gold. The Creditanstalt debacle reveals how efforts to paper over bank troubles turned Austria into the weak link in Europe’s financial chain. But while domestic authorities may have been too soft on Austrian banks, Hans Kernbauer reminds us that foreign advisers were also too narrowly focused on fiscal and monetary discipline, to the neglect of financial fragilities. Back in 1924, they had vetoed an ambitious plan to re-capitalize Austria’s financial system on grounds of expense. With more radical measures off the table, mergers were instead used to paper over banking-sector weaknesses. This precarious financial edifice came crashing down in 1931.

More broadly, central banks designed to fight deficit-fuelled inflation were ill prepared to address financial fragility. Like the earlier institutions after which they were modelled, they did not consider prudential supervision as part of their mandate.Footnote ¹⁹ Nor did they have the expertise, information, and instruments needed to regulate the financial system. The Bank of Greece, for example, lobbied tirelessly for legislation requiring commercial banks to disclose detailed financial information and hold mandatory reserves, in a futile effort to control a market dominated by its predecessor, the National Bank.Footnote ²⁰

Not that all new institutions were keen to police their banks. With more power came more responsibility, and a central bank responsible for commercial banks might be expected to act as a lender of last resort at times of crisis. Given a mandate to uphold the exchange rate at any cost, interwar central banks were at best ambivalent about this role. Intervention on behalf of the banking system invited speculation against the exchange rate; if investors feared devaluation, capital flight would undermine both the liquidity of the financial system and the central bank’s foreign exchange reserves. Thus, lender-of-last resort interventions were not only ineffective but could be counterproductive.

With the onset of the Depression, policymakers thus found themselves on the horns of a dilemma. The orthodox response was to stay on gold, raise taxes and discount rates, cut spending and credits, and thus preserve the foreign exchange necessary to maintain convertibility and service the country’s external obligations. This is what most countries did initially, while struggling to secure additional loans and re-negotiate existing liabilities, including war debts and reparations.

The alternative was to abandon the gold standard and reflate, prioritizing output and employment over the currency peg. But this was unappealing for countries that had struggled to return to international markets in the 1920s. Inasmuch as the gold standard inspired investor confidence, devaluation threatened access to foreign capital. Moreover, debtors with substantial foreign-currency liabilities would be hard pressed to avoid default if that debt was revalued, and default could trigger commercial retaliation if creditor nations imposed sanctions or raised tariffs.

There was also a third option, but it required international cooperation. Monetary expansion in surplus countries (as per the rules of the game), coordinated central bank intervention to support the exchange rate in countries facing financial distress, a general moratorium on debt and reparations payments, and even simultaneous devaluations could have mitigated adjustment pressures and deflation. But cooperation was hindered by divergent interpretations of the challenge at hand and divided opinions on such matters as war debts and reparations. Moreover, the very asymmetry inherent in the gold standard – that deficit countries felt pressure to adjust while surplus countries did not – undermined the symmetry of the international reaction.

Multilateral organizations, for their part, were little help. In Chapter 3, on the League of Nations, Clavin singles out the Gold Delegation’s inquiry into the operation of the gold standard, launched in 1928, as a turning point in the relationship between central banks and the League. Portrayed as technical, the inquiry inevitably acquired political overtones: any discussion of global monetary conditions raised questions about French and American gold accumulation that neither country wished to entertain. The Bank of England was not willing to jeopardize relations with the Federal Reserve, whose officials disapproved of the League’s proceedings and advocated moving the Delegation’s work to the BIS, newly created as a venue of central bank cooperation.

In the event, the BIS proved no more able than the League to muster a concerted response. An attempt in 1930 to provide credit facilities for investment faltered when the BIS’s Directors discovered that the Bank’s own liquidity was limited. A plan to finance a corporation to issue bonds and provide long-term credits was stymied by French concerns that it would drain capital from the Paris market. And the emergency loan to the Austrian central bank during the Creditanstalt crisis was only half what Austria requested and failed to stem the tide. Piet Clement asks whether these failures reflected difficult economic conditions or strained political circumstances. Without minimizing economic difficulties, he emphasizes the role of political conflict. Reparations were still outstanding, and the United States opposed any revision that might compromise its war debt claims. Opposed to the recently announced Austro–German customs union, France angrily scuttled proposals for a more ambitious Austrian rescue.

Left to fend for themselves, emerging markets could either defend the exchange rate at the expense of economic activity; or accommodate their economy and financial system at the cost of abandoning the gold standard. Most took the orthodox route at first, hoping to secure a trickle of foreign capital. But as the trickle dried up entirely, their position became increasingly untenable, and they began leaving gold. After sterling’s devaluation in September 1931, these departures became a stampede. By the summer of 1933, when US President Franklin D. Roosevelt decried the ‘old fetishes of so-called international bankers’, Poland was one of the last developing countries still on the gold standard, not least because of its political and financial ties with Paris.Footnote ²¹

Departures from gold took different forms (Table 1.2). Devaluation was most common. But in countries where inflation had been steep, devaluation evoked memories of hyperinflation. Such countries therefore chose to combine capital controls with protectionism in order to ration foreign exchange and/or alter the de facto exchange rate while maintaining the de jure price of currency in terms of gold. Both Bulgaria and Hungary resisted altering their official exchange rates but were drawn into elaborate clearing arrangements with Germany. The Turkish lira also spent most of the 1930s officially pegged to gold, enjoying nominal stability behind stringent controls. Developing countries choosing to devalue were in any case reluctant to let their exchange rate float, so they sought to join one of the emerging currency blocs into which the post-1931 world was fragmented (Urban, Reference Urban2009). Most British Dominions, with the exception of Canada, quickly joined the sterling area. Greece let the drachma float for a few months before re-pegging to gold and following the Gold Bloc from a distance. Chile and Colombia imposed exchange controls in 1931 and devalued in 1932, after which their currencies followed the dollar.

At this point, the choice between outright devaluation and the pretence of a gold peg, propped up by protectionism and exchange controls, became secondary. What mattered now was whether governments and central banks, having regained a modicum of monetary autonomy, opted to use it. Since many exchange-control countries had histories of high inflation, policymakers were often reluctant to reflate aggressively. Eichengreen (Reference Eichengreen1992) compares countries that devalued with those maintaining the façade of the gold standard behind exchange controls. He confirms that exchange control countries were more reluctant to increase money supplies.

Timing also mattered. Countries that unshackled themselves sooner recovered faster (Eichengreen and Sachs, Reference Eichengreen and Sachs1985; Campa, Reference Campa1990). The depth of recessions in Poland and Czechoslovakia, to mention the most obvious examples from this volume, illustrate the costs of waiting too long before abandoning gold.

1.6 Central Bank Fetters

Were central banks uniformly part of the problem that was the Great Depression? After all, these institutions had been designed to uphold the gold standard, whose failings contributed to the depth of the Depression. Indeed, Simmons (Reference Simmons1996) argues that greater central bank independence perversely increased the system’s deflationary bias: zealous to stave off inflation, central banks in surplus countries were reluctant to increase their money supplies. By sterilizing gold inflows they deviated from the ‘rules of the game’ and shifted the entire adjustment burden onto deficit countries.

This line of criticism, developed in the earlier literature, focused on leading central banks in industrialized nations, specifically France and the United States, rather than on newly established banks in emerging markets. We have already mentioned how many central banks in emerging markets often had little leverage over domestic credit conditions. In the early stages of the Depression this handicap was a blessing, insofar as they lacked the policy tools to engineer an even more powerful monetary contraction. Moreover, the handful of tools at their disposal was frequently used to mitigate, rather than exacerbate, deflation. This is apparent in their lender-of-last-resort interventions, which – as the Austrian example reveals – led to further drains of foreign reserves, as well as in a reluctance to let foreign exchange losses affect domestic circulation (see the cases of Hungary and Greece). Unlike France and the United States, most emerging markets were deficit countries, where breaches of the rules of the game were countercyclical and reflationary rather than deflationary.

Ultimately, of course, such interventions were futile: they could neither offset deflation nor continue indefinitely so long as gold convertibility was maintained. Eventually reserves would run out and the policy trilemma would bind, at which point exiting the gold-standard system might become irresistible (Obstfeld et al., Reference Obstfeld, Shambaugh and Taylor2004). Did new central banks affect the timing of these exits? The evidence doesn’t speak clearly. Flores Zendejas and Nodari point out that Latin American countries still without a central bank were actually first to devalue. Focusing exclusively on eight European countries with central banks, Wolf (Reference Wolf2008) finds that those with more independent institutions abandoned the gold standard earlier.Footnote ²² Wandschneider (Reference Wandschneider2008) expands the sample to twenty-four countries but finds no correlation between central bank independence and the decision to leave gold.

Different conclusions reflect different country samples, but they are also indicative of the difficulty of quantifying central bank independence.Footnote ²³ Interwar money doctors, like modern quantitative economic historians, focused on bank statutes as their measure of independence.Footnote ²⁴ Statutory provisions alone, however, cannot shield central banks from interference, any more than they can depoliticize an inherently political process.Footnote ²⁵ This is especially true of newly established institutions, which have little time to build reputations or forge domestic political alliances.

Foreign allies, when present, failed to make up for this shortfall. This is not surprising: where statutory independence had been a symbolic gesture designed to placate foreign creditors, it was disregarded once international lending collapsed after 1929. In Czechoslovakia, for example, Jakub Kunert points out that the Banking Office, legally a department of the Ministry of Finance, was arguably more independent than its successor, the central bank, which was overruled by the government on exchange rate policy. In Poland, the regime of Józef Piłsudski eagerly awaited the term of the American central bank adviser to end so that it could ‘stage a war to subjugate the Bank of Poland to the government’ (Leszczyńska, Section 7.6). In Greece, the decision to stay on gold after sterling’s devaluation was taken by the prime minister, who dismissed the central bank governor.Footnote ²⁶

Although distinguishing de facto from de jure independence is useful, doing so still doesn’t provide an unambiguous guide to 1930s gold-standard policy. Some independent central banks resisted political pressures to devalue, but others faced the opposite challenge of resisting pressure from the government to stay on gold. By 1929, Poland’s Piłsudski had effectively subjugated the central bank; its foreign adviser was gone, and a new governor, Władysław Wróblewski, had replaced his less compliant predecessor. As the recession deepened, the Bank of Poland recommended leaving the gold standard, only to be overruled by the government, Piłsudski insisting that a strong currency was needed to avoid inflation.Footnote ²⁷ Similarly, Pamuk explains how the Turkish monetary authorities remained conservative in the 1930s despite autonomy from the government. Recalling high inflation during the First World War, they were unwilling to experiment with the lira.

This brings us to a central theme of this volume. Central banks are embedded within a broader network of institutions, political and societal relations, shared experiences, and ideas that shape their actions and effects (McNamara, Reference McNamara2002: 55). In this context, establishment of a new, independent central bank and subsequent pursuit of monetary orthodoxy, rather than one determining the other, may both reflect a deeper common cause. Harold James hints at this when he reaches back to Adam Posen’s (Reference Posen and O’Brien1993) seminal paper on the role of financial interests and history in creating a broader ‘culture of stability’ that explains both low inflation and central bank independence.Footnote ²⁸ Memories of past inflation discouraged developing countries from leaving the gold standard in the 1930s, just as they had encouraged the establishment of independent central banks in the 1920s. Even where new banks were associated with more orthodox policy, the effect was not necessarily causal.

If the advent of new central banks does not explain subsequent policy choices, then what does? Why did some countries take longer to leave the gold standard than others? The possibility that they might be able to continue borrowing made some countries more patient, as we have seen. So did concerns over foreign retaliation in the event of a debt default. The association of the return to gold with national prestige discouraged politicians from sacrificing the political capital invested in stabilization. Interest groups standing to lose from devaluation defended orthodox policy, while those hurt by deflation pushed back (Frieden, Reference Frieden2014). Less democratic regimes were able to ignore such pressures for longest. In emerging markets, fear of inflation was compounded fear of floating (Calvo and Reinhart, Reference Calvo and Reinhart2002), which is why governments opted for capital controls and re-pegged after devaluing. It is why none of the countries discussed in this volume used their new-found freedom to pursue aggressive monetary expansion (cf. Mitchener and Wandschneider, Reference Mitchener and Wandschneider2015). The experience of the 1920s made policymakers err on the side of caution. The tragedy in the deflationary circumstances of the 1930s was that caution was the last thing required.

1.7 The Legacy

Surveying the landscape of interwar central banks, the Canadian economist Wynne Plumptre noted that ‘one of the primary tenets of accepted central banking thought has been the importance of keeping central banks politically independent’ (Plumptre, Reference Plumptre1940: 23). By the time this sentence was written at the end of the 1930s, it was already out of date. In the wake of the Great Depression, an event widely interpreted as signifying the failure of market liberalism, governments reclaimed the powers delegated to central banks.

Often, radical measures had to await a new government. Following sterling’s devaluation in 1931 and the shift from Labour to the new Conservative-led National Government, Norman noticed an ‘immediate redistribution of authority and responsibility’ from the Bank to the Treasury (cited in Clay, Reference Clay1957: 437; see also Kynaston Reference Kynaston, Roberts and Kynaston1995). In the United States, the Roosevelt administration pushed the central bank aside; a series of legislative reforms, starting with the Thomas Amendment granting the President the power to alter the dollar price in gold, curtailed the independence of the Federal Reserve.Footnote ²⁹ Similar steps were taken by Leon Blum’s government in France shortly before the Gold Bloc unravelled in 1936 (Mouré, Reference Mouré2002: 221–226).

Central banks in emerging markets followed suit, as their recently acquired powers were returned to national governments. Governors were replaced; statutes were revised. In New Zealand, the Reserve Bank built at Niemeyer’s behest was barely two years old when the new Labour government nationalized it.Footnote ³⁰ Most banks surveyed in this volume experienced a shift in the locus of power. Those that did not either had little power to begin with (as in India) or faced a divided government too weak to impose its will (for example Australia).Footnote ³¹

Signalling the ‘triumph of discretion over automaticity’, the departure from gold gave policymakers leeway to experiment (Cairncross and Eichengreen Reference Cairncross and Eichengreen1983: 4). In Latin America, central banks engaged in re-discounting and open-market operations in an effort to encourage reflation. These policies have been heralded as a reaction against money-doctor orthodoxy and a mark of monetary emancipation. But Flores Zendejas and Nodari argue that the reality was more complex, at least when it comes to Edwin Kemmerer, who himself became a champion of counter-cyclical monetary policy in the 1930s and nudged Latin American central bankers toward greater activism.

Simultaneously, the rise in state activism involved central banks in additional facets of economic policy. From the 1930s, they were called on to manage clearing balances and exchange stabilization funds, provide liquidity to the state and banking sectors, and refinance specialized credit institutions’ lending to farmers and industry. Tasked with administering exchange controls and clearing arrangements, they became agents of regulation and dirigisme. Their organizational charts and employee rosters expanded accordingly. The Bank of Greece, having started with a spartan staff of 400 in 1928, employed almost 2,200 people in 1940. Bulgaria’s Finance Minister noted in 1933 how the country’s ‘entire economic life [was now] concentrated’ in the hands of the central bank, a transformation that paved the way for its future role as the communist monobank (Avramov, Section 10.6). In the aftermath of banking crises, and now freed from the gold standard, central banks embraced their role of lenders of last resort. In some cases, that role extended to prudential supervision and bank regulation. Central banks took advantage of their new relationship to the state and of the swing of opinion against financial liberalism to consolidate their authority and tilt the balance of power away from commercial banks.Footnote ³²

These late 1930s trends then were reinforced by the exigencies of the Second World War. Now fiscal dominance was expected, not abhorred. Following the war, acute dollar shortages threatened post-war reconstruction. Borders again were redrawn, while Britain and France became embroiled in a reluctant retreat from empire not unlike that experienced earlier by the Austrians and Ottomans. Interwar history seemed destined to repeat itself.

But this time was different. Thanks to memories of interwar experience, reparations and war debts were minimized. With the advent of the Cold War, the United States financed Europe’s trade deficit with Marshall Plan funds. The international monetary system was redesigned following Anglo-American blueprints negotiated at Bretton Woods. Exchange rates were again pegged, but now they were made more adjustable. Capital controls were authorized to shield countries from destabilizing hot money flows, and the IMF was charged with monitoring economic policies and helping countries with balance of payments difficulties. Much like its interwar predecessors, the Fund fashioned itself as an apolitical, rule-based agent of international cooperation. Continuity extended to personnel: Per Jacobson, an early member of the EFO staff transferred to the BIS in 1931, became IMF managing director in the 1950s.

For central banks, the end of the Second World War did not signal a return to earlier concerns over independence and financial liberalism. To the contrary, central banks coordinated closely with governments and continued to expand their range of responsibilities and interventions (Singleton, Reference Singleton2011: 128ff). Policy implementation now relied on direct controls (lending caps, reserve requirements, restrictions on bank asset holdings, and so on), while exchange controls provided leeway to pursue domestic policy objectives without sparking immediate balance of payments problems (Eichengreen, Reference Eichengreen2019). Policy outcomes were favourable, though whether this was a cause or consequence of the post-war golden age of economic prosperity is debatable.

In this new post-war environment, central banks possessed less independence but more power. Under Soviet-style central planning, the extreme case, they were fully integrated into the state-owned banking apparatus. But even elsewhere, emphasis on state intervention and modernization meant that central banks established in the 1920s and 1930s now became instruments of development policy, allowing the authorities to allocate credit and target industries in pursuit of economic growth. Before long, they were joined by another post-colonial wave of new central banks. The gold standard was gone, but the call at the 1920 Brussels Conference for all nations to establish their own central banks echoed down the years.

The coda then came in the 1980s and 1990s, as additional reforms were put in place in response to the failures (as well as the successes) of these credit-allocation and targeting policies, and specifically in response to the problem of accelerating inflation. This entailed renewed emphasis on the virtues of central bank independence (Bade and Parkin 1982; Alesina and Summers Reference Alesina and Summers1993). That emphasis manifested itself in steps to enhance the independence of established central banking institutions (the Bank of England, for example) and in the creation of new ones (the European Central Bank, arguably the most independent central bank of all). The reforms of the 1920s anticipated this contemporary paradigm. A look back at that history, through the lens of the studies that follow, sheds light on the circuitous route by which we got here.