No. 1042 - When did the balance sheet become a monetary policy tool? Evidence from Banca d'Italia across the 20th century
This paper examines the evolution of Banca d'Italia's balance sheet from its foundation to the launch of the euro area's single monetary policy and analyses its relationship with the main macroeconomic developments in Italy. The study contributes to the ongoing debate on the balance sheet policies adopted by central banks over the last two decades by providing empirical evidence on the role played by central bank balance sheets as instruments of monetary policy in earlier periods.
Throughout the 20th century, Banca d'Italia's balance sheet contracted in response to inflationary shocks and exchange rate depreciations, whereas balance sheet expansions were followed by increases in GDP and inflation, exchange rate depreciation, and growth in the country's international trade. These findings suggest that the central bank's balance sheet functioned de facto as a monetary policy instrument. The relationship between balance sheet size and policy interest rates became strongly positive from the 1980s onwards.
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