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Central Banks at War

Published online by Cambridge University Press:  21 October 2014

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Abstract

War is expensive—troops must be equipped and weapons must be procured. When the enormous borrowing requirements of war make the sovereigns' credibility problem more difficult, central banks enhance a government's ability to borrow. By being the sole direct purchaser of government debt, the central bank increases the effective punishment that can be imposed on the government for defaulting on the marginal lender. This increases lenders' confidence that the government will be punished in case of default, making lenders willing to purchase the debt at a lower rate of interest. The sovereign, dependent on the low borrowing costs offered by the central bank, has an incentive to retain the bank. Data covering the nineteenth and early twentieth centuries reveal that possessing a central bank lowers the sovereign's borrowing costs, particularly during times of war.

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Research Article
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Copyright © The IO Foundation 2015 

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Footnotes

I thank Ted Brader, Lawrence Broz, Rosella Capella, William Roberts Clark, Gary Cox, Mark Dincecco, Marc Flandreau, Benjamin Fordham, Page Fortna, Gerhard Glomm, Katja Klienberg, Sarah Kreps, James D. Morrow, Yotam Margalit, Brian Min, Pablo Pinto, Tonya Putnam, Daniel Rieter, Michael Rubin, Patrick Shea, Ken Shultz, David Stasavage, Allan Stam, Johannes Urpelainen, Nicholas Valentino, Jana Von Stein, Todd Walker, Barry Weingast, two anonymous referees, and Jon Pevehouse for helpful comments and guidance. Earlier versions of this article were presented in seminars at Binghamton University, Columbia University, Indiana University, Miami University, and the University of Michigan. All errors are the sole responsibility of the author.

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