Central Bank Swaps Then and Now: Swaps and Dollar Liquidity in the 1960s

The Federal Reserve’s decision to offer ultimately open-ended swap lines to other central banks in the wake of disturbances to the global financial system in 2007 has attracted considerable academic attention and some political controversy. While empirical research has generally found that the post-2008 swaps were effective in providing dollar liquidity, some members of the US Congress have criticized the system for not serving the US national interest and for using American resources to bail out European banks. The limited number of countries able to benefit directly from the Fed swaps has also been criticized for unduly reducing the scope of this instrument.

A new working paper paper by Robert N. McCauley and Catherine R. Schenk explores the record of central bank swaps to draw out four themes. First, this recent device of central bank cooperation had a sustained pre-history from 1962-1998, surviving the transition from fixed to floating exchange rates. Second, Federal Reserve swap facilities have generally formed a part of a wider network of central bank swap lines. Third, the authors take issue with the view of swaps as previously used only to manage exchange rates and only more recently to manage offshore funding liquidity and yields. In particular, McCauley and Schenk spotlight how the Federal Reserve in the 1960s, working in conjunction with the Bank for International Settlements and European central banks, repeatedly used swaps to manage eurodollar funding liquidity and Libor yields. Fourth, this earlier cooperation underscores the Federal Reserve’s use of swaps to prevent eurodollar shortages from interfering with the transmission of its domestic monetary policy.

The working paper’s archival evidence undermines the sharp distinction drawn between swaps in the 20^th and 21^st centuries. Resurrecting the largely forgotten history of the 1960s swaps system exposes the precedents for international central bank cooperation, the scope for innovation and the way the Fed used swaps both at their origins and in 2007-08 to manage US monetary transmission.