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Macroeconomics and Financial History

Final Report Summary - MACROHIST (Macroeconomics and Financial History)



The 2008 global financial crisis generated a vigorous debate about the state of macroeconomics and macroeconomic training. The crisis raised awareness about deficiencies in the economic training which graduate and undergraduate students receive. A major criticism is that young economists lack expertise on the intricacies of the financial system, ignore why financial crashes and panics occur, and often remain agnostic about what specific policies are required during times of crises. At the macro-political level, these gaps and discrepancies inevitably result in suboptimal policy decision-making and vulnerability to market downturns. Strikingly, many employers –from both the public and private sectors– are now arguing that knowledge of economic history might be particularly useful. A knowledge of economic and financial history is crucial in thinking about macroeconomic problems and the financial sector in several ways. First, it forces students to recognize that major discontinuities in economic performance and economic policy regimes have occurred many times in the past, and may therefore occur again in the future. Second, economic history teaches students the importance of context. Finally, exposure to economic history leads to an empirical frame of mind, and a willingness to admit that one's preferred theoretical framework may not always work in explaining the real world. These are essential habits for young economists wishing to apply their skills in the work environment. Young macroeconomists need training in economic and financial history. Equally, students of economic history need exposure to the techniques of modern macroeconomics and financial economics.

The major scientific objective of MACROHIST was to promote work in macroeconomics and financial economics which is both up-to-date methodologically, and historical in sensitivity, in the sense that it is: motivated by real-world issues; sensitive to the importance of institutional context; and open to being informed by past experience. This does not imply that all the work that the network engaged in was explicitly historical. In addition to promoting research on long-run datasets, running in some cases from the nineteenth century to today, MACROHIST also allowed researchers to study "once in a generation" events, such as the current financial crisis, in a far more systematic manner than is possible by merely focusing on very recent data.

The major training objective of MACROHIST was to bridge the gap in training which exists between macroeconomists, who may be largely ignorant of its history, and economic historians studying macroeconomic and financial history, who may be naive about the tools that are required to make sense of a complex empirical reality. We achieved this objective by exposing young researchers to the training provided by both sub-disciplines; and by involving them in cross-disciplinary research projects which combine theoretical and empirical sophistication, on the one hand, with a historical sensitivity to context on the other. MACROHIST drew not only on the training programmes of the partner institutions, which reflect their differing disciplinary backgrounds, but also provided a series of network-wide training events explicitly geared towards young researchers in macroeconomics and macroeconomic history.

The research aims of MACROHIST were organized along three Work Packages: the causes and consequences of financial crises (WP1); the role of macroeconomic policies and policy regimes in promoting macroeconomic stability and reacting to crises (WP2); and the longer-term relation between finance and growth, encompassing the dimensions of financial innovation, development (domestic and cross-borders) and regulation (WP3). The outputs of the research projects undertaken by the 24 MACROHIST fellows map onto the three Work Packages as follows.
Within WP1, the network completed two projects, the first compiling a large dataset of sovereign debt haircuts from 1820 to the present. The second project contributed to our understanding of the causes of financial crises by identifying a link between government guarantees to foreign investment in protected sectors and the occurrence of crises. This ‘diabolic loop’ was recently invoked to explain the 2008 financial crisis, but it was already active in the 19th century.

The WP2 contributed with research on five areas. One project investigated the set up and working of the Latin Monetary Union (1865-1927) focussing on how it shaped the monetary and fiscal policies in the member countries and, in particular, how it constrained the monetization of budget deficits of “problem countries” in the European periphery. This research contributes to the cognate debate on the European Monetary Union. The promotion of trade integration was a second avenue for research within this WP. One study focused on how the LMU promoted integration of trade flows between its members, paying special attention to the asymmetries in the distribution of costs and benefits originating from integration. The political economy of trade protection was the object of another study, which uses very detailed information on pressure groups and government bodies to model the use of retaliatory tariffs by the Russian Empire and their impact on international trade. A third research project engages with the topical subject of foreign exchange (FX) reserve management by central banks. It focuses on a non-obvious period, the Bretton Woods era, when a quasi-universal peg to the dollar coupled with US hegemony should have made for a relatively simple FX management. A new international database of national FX reserves reveals a more active portfolio management by central banks than expected, with implications for their monetary policy choices. A fourth line of research uses state-of-the-art Bayesian structural methods to estimate the impact of monetary policy on economic stability and growth in the US since the 1920s. Overall, this study supports the view that periods of greater economic instability were associated with worse conduct of monetary policy (and vice-versa). Moreover, it shows that changes in policy stance were driven by larger-than-usual macro shocks, particularly affecting the banking sector. The final project in this WP approached the relation between macro policy and economic outcomes from the reverse angle. Two papers in this project show a causal link between the economic structure of French regions and political preferences, particularly for more authoritarian regimes.

In the third Work Package, under the heading of financial globalization, the network contributed a large dataset of capital flows between 1880 and World War I, disaggregated by recipient nations and industries. This dataset was the basis for a number of papers, namely, on the drivers of foreign capital to emerging nations and on the relation between sovereign debt crises and credit rationing to firms in defaulting nations. Another novel dataset gathers data on the European housing market since 1970 and uncovers the short- and long-run dynamics of the real estate market in the future EMU member states. In particular, this study shows that demand patterns for housing (e.g. driven by demographic trends) converged early in the process of European integration, contrary to supply forces, namely regulation. From this emerges a new history-based explanation for Germany’s unusually stable real estate market in the European context and a new awareness of the importance of harmonizing housing regulations within the EMU. A separate study in this project connects international labour mobility and real estate, by confirming a well-known conjecture about the link between the rate of home ownership and local unemployment.
The origins of financial regulation are studied in two projects on the political economy of US banking regulation since the 1970s and on the origins of credit rating agencies also in the US. The latter study reveals how private firms initially competed with federal regulators for providing ratings on corporate borrowers, but later gained a monopoly on ratings, endorsed by the same regulators. Another project deals with regulatory capture in the early British railway boom of the 1840s. Using network analysis, this project shows that British politicians favoured railway projects in which they or their voters had a vested interest, which were not necessarily the lines with greater social value.

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