Your word and your bond: Central Banks and sovereign lending in civil wars, 1815–1914

Abstract

All wars are expensive, but civil wars carry heightened stakes. Defeat can mean loss of territory, the dissolution of the sitting government, or the liquidation of the state itself. Even a victorious government may face tremendous crises and pressures in the short-term. A central bank can signal a sovereign’s creditworthiness to potential lenders, but the bank’s independence (or even existence) can be terminated should a government wish to do so. Despite this, lenders not only continue to lend to governments amidst civil wars but also respond to signals of creditworthiness such as the presence of an independent central bank. Using several statistical models and bond yield data from the nineteenth and early twentieth centuries, I demonstrate that the presence of a central bank reduces sovereign borrowing costs for a state amidst a civil war. This confirms the institution’s ability to secure cheap wartime capital under suboptimal conditions.