John H. Wood, _A History of Central Banking in Great Britain and the
United States_. New York: Cambridge University Press, 2005. xv + 424
pp. $90 (cloth), ISBN: 0-521-85013-4.
Central banks in Great Britain and the United States arose early in the financial revolution. The Bank of England was created in 1694 while the first Banks of the United States appeared in 1791–1811 and 1816–36, and were followed by the Independent Treasury, 1846–1914. These institutions, together with the Suffolk Bank and the New York Clearing House, exercised important central banking function before the creation of the Federal Reserve System in 1913. Significant monetary changes in the lives of these British and American institutions are examined within a framework that deals with the knowledge and behavior of central bankers and their interactions with economists and politicians. Central Bankers’ behavior has shown considerable continuity in the influence of incentives and their interest in the stability of the financial markets.
Features:
• Only recent financial history title comparing the US Federal Reserve Systemand the Bank of England in depth
• Author has been writing on the topic for over 35 years and is well known
• Writing is clear, accessible, engaging
Contents
1. Understanding monetary policy;
2. An introduction to central bankers;
3. Making a central bank: I. Surviving;
4. Making a central bank: II. Looking for a rule;
5. Making a central bank: III. Ends and means;
6. Central banking in the United States, 1790–1914;
7. Before the crash: the origins and early years of the Federal Reserve;
8. The fall and rise of the Federal Reserve, 1929–51;
9. Central banking in the United States after the Great Depression, 1951–71;
10. The Bank of England after 1914;
11. Rules vs. authorities;
12. Permanent suspension;
13. Back to the beginning? New contracts for new companies.
Reviewed for EH.NET by Angela Redish, Department of Economics,
University of British Columbia.
In 1694 a group of merchants agreed to lend the English government
£1.2 million in exchange for a charter to create a note-issuing bank,
the Bank of England. Two hundred and twenty years later, in response
to private sector rather than public sector concerns (notably the
panic of 1907), the United States created the Federal Reserve Bank.
Focusing on the UK and the United States, this book studies the
transition from a seventeenth-century world free of central bankers,
through the financial excitements of the eighteenth, nineteenth, and
twentieth centuries to the sedate world of central banking in the
late twentieth and early twenty-first centuries. The focus is on the
interplay between bankers and politicians and on the evolution of an
in-between species, the 'central bankers.'
As the author, John Wood (Department of Economics, Wake Forest
University), notes it is a propitious time to write such a book.
Central banks are operating in a period of calm, and are widely seen
as so successful that they are boring. In both the U.S. and the UK,
the twentieth century posed extreme challenges for central banking:
financing two world wars, facing the shocks of the Great Depression,
and then learning how to operate in a fiat money world after the end
of the Bretton Woods period. Since the early 1990s, there has been
widespread agreement on the appropriate targets of monetary policy --
price stability and financial stability -- and, perhaps with the
exception of how to respond to "irrational exuberance" in asset
markets, central banking has become a technocratic business of
forecasting future demand so as to set interest rates at an
appropriate level to engender price stability.
How independent should a central bank be in a democratic country? The
book takes us through the ups and downs of independence. Today many
central banks, including the Bank of England and the Fed, have
operational independence but are subject at some horizon to state
control, but the degree of independence has fluctuated. At its
origins the Bank of England was private, and the fiscal needs of the
government gave the Bank considerable power, but by 1833, after years
of stable public finances, the government could "afford the luxury of
an independent central bank" (p.72). (Interestingly, Wood's evidence
of independence is the introduction of a requirement for the
publication of the Bank's accounts which would make explicit any
changing indebtedness of the government.). In the 1920s, the Bank of
England was dominant in the decision that Britain would resume
convertibility of the pound at the old par, despite the deflation
that this would require, but after World War II, it was the
politicians and Treasury officials that determined interest rates as
well as exchange rate policy. In the second half of the twentieth
century the Bank considered itself as merely the "central banking arm
of a centralized macroeconomic executive" (p. 386), but then, after
decades of erratic monetary policy, the Bank was given its
independence in 1998.
The independence of the Federal Reserve System is even more tortuous
to describe because of its diffuse structure, itself a reflection of
the desire to create a bankers' bank _and_ a government bank. The Fed
is composed of twelve regional banks plus the Board of Governors
located in Washington, and tensions between bankers and the
government were frequently played out between the Board and the
regional (especially New York) Feds. Again the degree of independence
fluctuated: the disagreements between the Board and the New York Fed
in the late 1920s are well known; in 1935, the system was reorganized
giving more power to the Board, and after World War II the Fed was
essentially subservient to Treasury desires for low interest rates.
The Fed's reassertion of its independence in early 1951 -- a showdown
between President Truman and Chairman Eccles -- is a story that
should be required reading for all students of monetary policy (pp.
226-38). Yet triumph was temporary, and in the 1960s and 70s monetary
policy became an issue in election campaigns. Most recently, at
Senate confirmation hearings in November, President Bush's nominee
for Chairman of the Board of Governors, Ben Bernanke, stated that: "I
will be strictly independent of all political influences and will be
guided solely by the Federal Reserve's mandate from Congress and by
the public interest."
The history of central banking is told against a backdrop of the
development of monetary theory and the evolving understanding of how
monetary systems and banks operate. The discussion of the real bills
doctrine, of 'operation twist,' of the use of moral suasion and
credit controls, of monetarism, and of price and wage controls takes
the reader through the, usually painful, learning that central
bankers have undergone. The author uses extensive quotations from
memoirs and minutes so that the reader can see the decision-making
process in the raw.
Now to cavils: There is an inherent organizational tension in telling
two stories chronologically in parallel. The author chooses to begin
with three chapters on the history of the Bank of England to 1914,
then three chapters on the origins of the Federal Reserve and its
history to the 1960s, then a chapter taking the Bank of England from
1914 to 1980, followed by three chapters that combine analysis of
contemporary monetary theory and the history of monetary policy in
both countries over the last 25 years. I'm not sure there is a better
way, but I found some of the transitions awkward. I suspect earlier
readers also did, as there are a large number of signposts for the
reader, which help, but still further prevent a seamless flow.
Finally a minor gripe: There are very useful summaries of events and
_dramatis personae_ at the beginning of each chapter, but some
curious choices are made. Beginning in 1951 the President of the
Council of Economic Advisors is listed, but nowhere are the New York
Fed Presidents listed; Governors of the Bank of England are not
listed until 1914; G. William Miller, Fed Chairman in 1978-79 is not
on any list. The lists would have been more useful as a reference if
they had been presented as comprehensive appendices to the whole book.
No individual event retraced here is new, but by bringing the pieces
together and focusing on the evolution of central bankers this book
enables the reader to see the forest rather than the trees, and
appreciate one of the successes of economics. This book will be a
useful resource for both economic historians and monetary economists
looking for a broad overview of the evolution of Anglo-American
central banking and monetary theory.
Angela Redish's publications include _Bimetallism: An Economic and
Social History_ (2000) and (with Michael Bordo) "Is Deflation
Depressing? Evidence from the Classical Gold Standard" in Burdekin
and Siklos, editors, _Deflation: Current and Historical Perspectives_
(2004).
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Excerto:
ONE: Understanding Central Bankers and Monetary Policy
Our monetary system is unprecedented. After decades of instability, central bankers, governments, and economists have reached a consensus that the appropriate role of a central bank in the prevailing fiat-money regime includes: (1) the clear assignment of the responsibility for inflation to the central bank; (2) agreement that inflation should be low and stable; (3) rejection of price controls as a means of controlling inflation; and (4) acceptance of whatever degree of fluctuation is required in interest rates to achieve the inflation objective. This is at once more ambitious and more modest (realistic) than earlier systems. The gold standard was a way to price stability in the long run, and Keynesian monetary and fiscal policies aspired to multiple (if inconsistent) price and quantity goals.
The system is not accidental. This book traces its development through successive interactions of central bankers, economic ideas, and governments, all affected in greater or lesser degrees by the experiences of earlier systems. There are several excellent histories of central banking for particular periods.1 However, this is the first attempt to tie the threads across three centuries within a unified framework that is made up not only of monetary theory but of the situations of central bankers in the financial markets. The story is told from the standpoints of central bankers in two countries, from the establishments of the Bank of England in 1694 and the Bank of the United States in 1791, although similar policy regimes in Europe and elsewhere suggest that it has wider applicability (which will be examined in the last chapter).
The focus on central bankers has several advantages for understanding the monetary system. Their position at the center provides a unique perspective on the progress of events, and their responsibility for day-to-day policy gives their exchanges with governments insight into policy in practice. The views of policymakers as revealed in the statements of Governors Whitmore, Harman, and Palmer before parliamentary inquiries in 1810, 1832, and 1848 are not found elsewhere; nor are Governor Hankey’s quarrel with the Economist’s Walter Bagehot, Governor Lidderdale’s reactions to the Crisis of 1890, Governor Norman’s defenses of resumption in the 1920s, the resistance of Governors Cobbold and Cromer to government pressures in the 1950s and 1960s, or Governor George’s exposition of the new consensus in 1998.2 The institutions of American monetary policy have been more changeable, but Nicholas Biddle’s defense against Andrew Jackson’s war on the Second Bank of the United States and the explanations of Treasury monetary policies by Secretaries Guthrie, Sherman, and Shaw and of Federal Reserve policies by Governors Strong, Harrison, Eccles, Martin, Maisel, Burns, Volcker, and Greenspan are equally valuable. Heads of Federal Reserve Banks were called governors before the Banking Act of 1935 (for example, New York’s Benjamin Strong and George Harrison); they were called presidents thereafter.
Finally, their common situation in the financial markets provides a strong element of continuity to the development of central banks. We will see how central bankers’ concern for financial stability has become reconciled with monetary policy. Technology has developed, but the fundamental characters of money and the credit markets, as well as of reputation and speculation, persist. Central bankers’ earliest and longest experiences were within the framework of the gold standard, but their intellectual positions have been similar under paper standards.
Instead of treating monetary episodes as distinct, I examine policy as a sequence of actions by durable groups with shared experiences and environments. In the 18th century, the Bank of England – the model central bank (although its directors had to be told at the end of the century that this is what they had become) – focused on profits and survival, the latter requiring the payment of gold on demand for its notes. The long 19th century – until 1914 – saw the progress of the Bank’s acceptance of a wider responsibility for financial stability, although convertibility remained in ascendance. The United States had no institution that could be called a central bank – except two short-lived Banks of the United States between 1791 and 1836 – before the establishment of the Federal Reserve in 1913. Nevertheless, the federal Treasury Department, central money markets, and clearinghouses performed central banking functions that were governed by the same ideas that prevailed across the Atlantic, that is, profits for private institutions and seigniorage for the government, subject to currency convertibility and with attention to financial stability.
Central bankers failed to cope with the disruptions of World War I and the Great Depression of the 1930s and tended to make matters worse as the old system collapsed. Monetary theory and practice since that time have to a large extent been quests for an adequate replacement of the pre-1914 system. The dollar-exchange system that was agreed at Bretton Woods in 1944 to achieve the solidity of the gold standard without its rigidity proved inconsistent with concurrent monetary stimulations, and its breakdown in the 1970s presaged an agonizing period of accelerating inflation and unemployment.
The anti-inflationary monetarist policies associated with Federal Reserve Chairman Paul Volcker and Prime Minister Margaret Thatcher may be understood as reactions to inflations that had failed to bring the promised benefits, and monetary debates since 1979 have led to the consensus just described. Commitments to the new policy were legalized in the Bank of England Act of 1998 and, less formally in the United States, by the statement of Chairmen Volcker that “price stability . . . is to be treasured and enshrined as the prime policy priority; that objective is inextricably part of a broader concern about the basic stability of the financial and economic system” and that of Chairman Greenspan, who stipulates, “Monetary policy basically is a single tool and you can only implement one goal consistently.”3
Nonetheless, we must pay attention to Greenspan’s warnings of “irrational exuberance in the stock market,” as well as his worries of a shift in bankers’ attitudes toward risk during the 1998 Asian financial crisis: “If there was a dime to turn on,” they did, he said. A “fear-induced psychological response is provoking a sudden rush to liquidity that poses a threat to world economic growth. . . . When human beings are confronted with uncertainty . . . they disengage.” Comparing investors to a pedestrian crossing the street, he observed, “When . . . you’re uncertain as to whether a car is coming, you stop.”4
Economists have been critical of central bankers’ attention to the financial markets at the expense of their macroeconomic responsibilities. Allan Meltzer was in the tradition of David Ricardo when he told a congressional committee in 1964 that the Federal Reserve’s “knowledge of the monetary process is woefully inadequate, . . . dominated by extremely short-run week-to-week, day-to-day, or hour-to-hour events in the money and credit markets. [T]heir viewpoint is frequently that of a banker rather than that of a regulating authority for the monetary system and the economy.”5
Notwithstanding these criticisms, we will learn how central bankers’ understanding of their role in monetary policy has grown. The stage for the intellectual gap between the two groups is set in Chapter 2, which examines the Bank of England’s denial of the Bullion Committee’s charge of economy-wide effects of what the Bank saw as normal lending practices. Its rejection of the risks and responsibilities of managing the currency was the occasion of Ricardo’s censure that opens the book. We will encounter more instances of this difference in viewpoint, but jumping ahead to 1998, we see that the conflict between the career central bankers and economists on the Bank’s Monetary Policy Committee (MPC) was similar to that between the Bank and the economists on the 1810 Bullion Committee.
According to the Monetary Policy Committee’s minutes, although the staff’s economic model recommended a rise in the Bank’s interest rate, Bank careerists favored “delaying any rise in interest rates, even if a rise were necessary.”6 They referred to “unusually large” near-term uncertainties and did not “feel very confident about the outlook and it would not necessarily be right to draw policy conclusions mechanically from the [staff’s] projection. In these circumstances there was a case for delay so as to allow judgment to be made later in the light of more information.” If the downturn proved sharper than expected, an increase in interest rates might have a severe negative effect on output, “and would have to be quickly reversed. Such a reversal could impair confidence in the economy” and create “confusion about monetary policy. . . . There was thus a strong case for waiting to get a clearer impression of the extent of the slowdown in the economy before taking policy action.”7
This thinking was like that of the Bank directors in 1819, who protested Ricardo’s money rule as “fraught with very great uncertainty and risk” in which “discretionary power is to be taken away from the Bank,” and might, because of the impossibility of deciding “beforehand what shall be the course of events,” impose “an unrelenting continuance of pecuniary pressures upon the commercial world of which it is impossible for them either to foresee or estimate the consequences.”
The 1998 Committee’s academic economists opposed this position by arguing that “policy should reflect the latest news and that uncertainty in itself was no reason for delay.” They believed that to delay decisions to reduce the risks of reversal was “irrational.” “So long as any policy reversals could be properly explained by new developments or improved analysis of the outlook, they need not create confusion about policy. . . . [T]he desire to minimise the risk of policy reversals was likely to mean that interest rate changes would, on average, be made too late.” The tie vote was broken by Governor George in favor of waiting.
Economists have found it “difficult to rationalize” central bankers’ concern for smooth interest rates and short-term stability in the financial markets.8 Nonetheless, they must take it into account. Central bankers cannot help behaving like bankers at least part of the time. Rules are incomplete, and if economists hope to explain and influence the conduct of monetary policy, they need to try to understand central bankers on their own ground. Central bankers are informed parties to the new consensus, but monetary policy results from the interplay of central bankers’ pragmatism with economists’ ideas and the wishes of governments.
The latter – the ultimate authority – cannot be ignored. The freedoms that central banks have been given can be taken away. Past government attitudes toward central banks have depended on their need for them. The end of war (and government pressure for cheap finance) brought an increase in the Bank of England’s independence in 1833 similar to that given in 1998. President Jackson’s veto of the renewal of the charter of the Bank of the United States in 1832 was influenced by the approaching end of the national debt. Senator Thomas Hart Benton declared, “The war made the Bank; peace will unmake it.”9
The greater independence of the Federal Reserve after the collapse of the Soviet Union might have reflected the government’s diminished need for finance as much as the public’s revulsion to inflation and disillusionment with the Phillips Curve. By the same token, the deficits arising from the War on Terror will bring pressure for monetization. In any case, monetary policy is at bottom a political decision.
Legislatures have also paid attention to central banks in peacetime, especially during the periods of price instability following wars, during the Great Depression, and in the 1970s. Monetary standards are decided by governments. The creation of the International Monetary Fund in 1944 and its rejection by President Nixon in 1971 were not unusual in the minimal roles played by the central bank. Wartime suspensions, devaluations, gold standard acts, and the creation of the Federal Reserve were political decisions. The task of central bankers even at the height of “independence” is the daily conduct of policy within the framework set by government.
Governments have taken direct control of monetary policy when they lost confidence in central banks. Their institutional shells remained, but monetary control was transferred in the early 1930s to the Treasury in both countries. The Federal Reserve regained control in 1951 when public opinion and Congress determined that the president had abused his monetary powers, a victory that had to be won again in 1979. The Bank of England, although possessing advisory influence, did not approach its former powers until the 1990s.
The last chapter surveys the present and speculates about the future of central banking. The current consensus rests on an understanding, developed over many years of hard experience, of what monetary policy can do. Central bankers apparently understand their assignment, although history shows that they also take the financial markets and political pressures seriously. Nevertheless, if we accept the goal of low inflation in free markets, with the understanding that this is the best that monetary policy can do, central bankers will be able to adjust to unusual events in ways that substantially deliver the goal while smoothing the financial markets – such as when the Federal Reserve supplied liquidity after the 1987 stock market crash, during the run-up to the millennium, and after 9/11, and also when it tries to soften the impact of monetary policy on the money markets by improving its transparency.10
TWO: An Introduction to Central Bankers
Do you consider the amount of Bank of England notes during the last year to have borne nearly the same proportion to the occasions of the public as in former times? – The same proportion exactly.
When you represent the quantity of Bank of England notes to be now only proportionate, as heretofore, to the occasions of the public, do you take into consideration the increased price of all articles and the consequent increase of the amount of payments; and do you assume that the quantity of notes ought to be increased in proportion to that increase of the amount of payments? – The Bank never force a note into circulation, and there will not remain a note in circulation more than the immediate wants of the public require; for no banker, I presume, will keep a larger stock of [the Bank’s] notes by him than his immediate payments require, as he can at all times procure them . . .
[Question repeated] – I have taken into consideration not only the increased price of all articles, but the increased demands upon us from other causes.
Minutes of Evidence, Bullion Committee, testimony of Governor John Whitmore, Bank of England, March 6, 1810
So went the opening exchange between the House of Commons’ Select Committee on the High Price of Gold (Bullion Committee), with Francis Horner in the Chair, and the Bank of England, represented by Governor Whitmore. This testimony played an important part in the beginnings of modern monetary theory and the intellectual discovery of central banking. Economists contended that the latter – monetary policy – properly derives from the former, while the central bankers resisted. The events surrounding the inflation that led to Parliament’s enquiry are presented in the first section in this chapter, followed by a review of the
Background: People and Events
1793: Beginning of the French Wars; financial panic.
1797: Suspension of convertibility.
1799: Income tax introduced.
1805: Austerlitz and Trafalgar; Napoleon supreme on land, England at sea.
1808: Wellington's Peninsular campaign begins.
1810: Bullion Committee; resolutions voted on, May 1811.
1812: Napoleon invades Russia.
1814: Napoleon abdicates, retires to Elba; Congress of Vienna.
1815: Waterloo.
Chancellor of
Prime Minister the Exchequer Political Parties
1783 William Pitt Pitt These were Tory
1801 Henry Addington Addington governments,
1804 Pitt Pitt with the King’s support,
1806 Lord Grenville Lord Henry Petty between the Whig
1807 Duke of Portland Spencer Perceval dominance under the first
1809 Perceval Perceval two Georges and its
1812 Earl of Liverpool Nicholas Vansittart resurgence in the 1830s.
Note: Short-lived ministries omitted.
Committee’s proceedings. Its members stressed in a modern way the effects of an unrestrained central bank on inflation through money creation. In an equally modern way, the Bank’s representatives denied responsibility and pointed to other causes.
The third section puts the debate into a longer term perspective by means of the best contemporary analyses of central banks. Henry Thornton explained in Smithian terms that there was much to be gained from a private central bank acting in the enlightened pursuit of its interests. Alexander Hamilton’s discussion indicates that similar forces and ideas were at work on the other side of the Atlantic, and prefaces the appearance of American central banking in Chapter 6. The last section reviews the Bank directors’ second thoughts about their responsibilities after a change in political circumstances.
War, Inflation, Suspension, and More Inflation, 1793–1810
The Bullion Committee was appointed on a motion by Horner on February 1, 1810, after two years of accelerating inflation, an adverse balance of trade, and a falling exchange rate. Horner, Henry Thornton, and others, although by no means the majority of the House of Commons, attributed these events to an excess of lending by the Bank of England made possible by the suspension in 1797 of its obligation, even its freedom, to redeem its notes for gold. War brought a growing public deficit as the government was slow to find revenue to match its increased spending. The Bank had complained of the government’s pressure for funds since 1794. That pressure slackened in 1795 and 1796, but the restoration of gold convertibility in France and uncertainty of British intentions sparked a decline in the Bank’s gold reserve from £6 million in February 1795 to £1 million in February 1797. When the drain was turned to panic by rumors of a French invasion and the Bank informed Chancellor of the Exchequer (and Prime Minister) William Pitt that its situation was desperate, he called a Council of State, which declared on February 26
that it is indispensably necessary for the public service that the Directors of the Bank of England should forbear issuing any cash in payment until the sense of Parliament can be taken on that subject and the proper measures adopted thereupon for maintaining the means of circulation and supporting the public and commercial credit of the kingdom at this important juncture.1
The order was confirmed by the Bank Restriction Act, passed on May 3, effective until June 24, and kept in force by continuing acts until 1821. Although the Act referred only to the Bank of England, other banks took the opportunity to refuse redemption of their notes, and before the end of the war the number of country banks had tripled.2 The public acquiesced, and the country’s monetary base was transformed from gold to Bank of England notes.
Later estimates (there were no contemporary price indices) indicated average inflation of about 3 percent per annum between 1797 and 1810.3 The Bank’s note and deposit liabilities grew about 6 percent per annum and the value of its notes at Hamburg, the exchange most often quoted, fell at an average rate of 2 percent.4
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