In his remarks at the closing Joint Sessions of the International Bank for Reconstruction and Development and the International Monetary Fund, more than 60 years ago, Greek economist and former Governor of the Bank of Greece Xenophon Zolotas stated that “… critical problems such as the numismatic plethora generate some agony and melancholy. This phenomenon is characteristic of our epoch. But, to my thesis, we have the dynamism to program therapeutic practices as a prophylaxis from chaos and catastrophe.”

Half a century later, the subprime crisis brought the global financial crisis, challenging both financial stability and conventional monetary policy. Zolotas would have claimed nowadays that the leading central banks have expressed their dynamism to program therapeutic practices as a prophylaxis from monetary chaos and financial catastrophe.

Yet this came at a huge potential risk regarding future financial and economic stability. As Mohammed El-Erian puts it in The Only Game in Town, the phenomenal growth of their balance sheets reflects a response by systematically important central banks which relied disproportionately on monetary policy. Although this unprecedented accumulation of assets did not alter the old theory paradigm — in the words of Milton Friedman (1984), “activist monetary policy will continue to be the bread and butter of monetary economics” — many riddles remain to be solved.

To be fair, international monetary cooperation goes a long way. In Central Bank Cooperation at the Bank for International Settlements, 1930–1973, Gianni Toniolo refers to Luigi Luzzatti back in 1907, who observed that financial problems in the US had created an international liquidity crisis (a “monetary famine” as he called it) from which the main central banks had tried to protect their respective markets, scrambling for gold through competitive interest rate increases and other means. According to Luzzatti, a “monetary war” of this kind was both detrimental and unnecessary; “peace” could be achieved through “cordial cooperation” in supplying gold to illiquid central banks. Central banks, Luzzatti said, lent to each other out of their long-term self-interest, but politics could get in the way of a clear vision of economic self-interest.

A hundred years later, central banks have been evolving as powerful institutions in the international economic system. In the aftermath of the Great 2007-9 Recession, international cooperation has led to a new paradigm of “monetary peace”: the coordinated action among USA, Germany and China, to maintain the status quo of the US dollar as a global reserve currency, in order to preserve the pre-crisis global monetary regime. Macroeconomic imbalances stemming from US trade and budget deficits and China’s accumulation of US debt, had been raising fears over a global dollar selloff when Lehman collapsed.

Yet the greenback did not lose its status as the world’s reserve currency. As Barry Eichengreen puts it, international policy cooperation is most likely when it is concerned with preserving an existing “policy regime”. Preserving the status of the US dollar was the incentive for central banks as policymakers to cooperate. First, the Federal Reserve System acted as international lender of last resort to foreign banks by establishing the swap-line system which included the major European central banks, such as the ECB, the Bank of England, and the Swiss National Bank, as well as those of Canada and Japan. Second, China’s central bank had re-pegged yuan to the dollar in July 2008 to June 2010. Third, when crisis hit the eurozone, European Central Bank did “whatever it takes”, thus keeping the euro’s value well below what the Deutschmark would be worth today if it still existed.

In his introduction to The Essential Keynes, Robert Skidelsky argues that John Maynard Keynes rests his theoretical structure on the existence of radical uncertainty. And yet, the question put forward by Minsky “Can this [crisis] happen again?” requires an answer that will be ultimately given by real life. Until then, central banks shall remain the only game in town.

Spyros Vliamos Dean, School of Economics & Business, Neapolis University Pafos, Cyprus and Professor Emeritus, Department of History and Philosophy of Sciences (HPS), National and Kapodistrian University of Athens, Greece.  

Konstantinos Gravas Capital Markets Professional, visiting Professor in the Hellenic Air Force Academy. PhD candidate, Department of History and Philosophy of Sciences (HPS), National and Kapodistrian University of Athens, Athens, Greece.