Paul Poast

Central Banks at War

Can central banks aid war efforts?

Both nondemocratic and democratic leaders have recognized the financial advantages central banks can accord governments during times of war. They can provide an enormous amount of capital in a short period of time and at a favorable cost. Using data on the London sovereign debt market from 1816 to 1914, Poast argues that possessing a central bank lowers the sovereign’s borrowing costs, particularly during times of war. 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. Future work can seek to answer a logical question posed by Poast’s findings:

If the presence of a central bank improves a government’s ability to borrow during times of war, does this, in turn, translate into better war effort, a higher likelihood of victory, or even a greater likelihood of peace?

International Organization (2015)

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The University of Chicago