When did the balance sheet become a monetary policy tool? Evidence from Banca d'Italia across the 20th century

This paper contributes to the ongoing debate on central bank balance sheet policies by examining the evolution of Banca d'Italia's balance sheet over the course of the 20th century. Using a range of VAR models, the analysis shows that in Italy, throughout the century, both balance sheet responses and impulses to macroeconomic conditions closely resemble those traditionally attributed to conventional monetary policy instruments, as well as those observed during recent episodes of unconventional balance sheet expansions. The paper therefore concludes that the central bank balance sheet functioned de facto as a monetary policy instrument throughout the century. Specifically, on the reaction function side, the balance sheet contracted in response to positive inflation shocks and exchange rate depreciations, while it expanded following positive shocks to real output and government debt. On the impulses side, exogenous balance sheet expansions were followed by significant increases in output, trade and inflation, as well as by exchange rate depreciation. A complementary analysis of balance sheet components shows that the composition of the balance sheet also changed over time in line with evolving macroeconomic needs. The role of the balance sheet changed from the early 1980s onwards, when policy interest rates became the primary instrument for controlling inflation internationally. Even in the latter part of the century, however, the balance sheet does not appear to have lost its function as a monetary policy instrument. Instead, it seems to have operated alongside the policy rate.