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2019 | OriginalPaper | Chapter

2. A Brief History of Central Banks

Author : Nils Herger

Published in: Understanding Central Banks

Publisher: Springer International Publishing

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Abstract

This chapter summarises the history of central banking. Key events of the history of central banks include the establishment of the first note-issuing banks during the seventeenth century, the era of the classical gold standard during the nineteenth century, the Great Depression and the Bretton Woods system during the twentieth century, as well as the European monetary integration and the Global Financial Crisis in recent decades. Across centuries, the economic role of central banks has changed dramatically. This process has eventually led to modern central banking, where monetary policy is used as a macroeconomic instrument to stabilise prices, the financial system, and economic activity.

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Footnotes
1
The origin of this quote is unclear. It is said to be from the prospectus for the Bank of England.
 
2
Note that paper money was not invented in Europe, but rather had already appeared centuries before in China (see Sect. 3.​2).
 
3
The Banque Royale is one of the earliest examples of a central note-issuing bank. In particular, in 1716, King Louis XV of France granted the Scottish economist and gambler John Law de Lauriston a charter to set up a bank, based on which he created an empire of merchant monopolies in France and overseas. A few years later, Law acquired also a monopoly to issue banknotes, which he used without restraint. Around the year 1720, the newly printed paper money created a massive bubble in the share prices of Laws’ merchant society, the ‘Mississippi Companie’. When this bubble burst, both the Banque Royale, under a massive amount of debt, and Law, under the psychological stress, collapsed. After the crash, the French economy was left with large amounts of worthless paper money. Arguably, due to this catastrophic experience with new forms of money, France became hostile towards financial modernisation for decades or even centuries. Indeed, the Banque de France was only founded in 1800 to restore monetary order, which had been undermined by another chaotic experiment with paper money, the so-called ‘Assignats’ issued during the aftermath of the French Revolution of 1789. For details see: Murphy, Antoin E., 1997: John Law Economic Theorist and Policy-maker, Clarendon Press.
 
4
To make their case, the currency school postulated a close connection between the money supply and inflation that would, in essence, resurface prominently with the Monetarists during the twentieth century. Because the stock of bullion should restrict the amount of money in circulation, the early supporters of strict control over the money supply were called ‘bullionists’. The currency school and the bullionists had considerable overlap in terms of both substance and representatives.
 
5
Peel’s Bank Act of 1844 did not apply to all parts of the British Isles. This fact is still evident today, as three retail banks in Scotland (Bank of Scotland, Clydesdale Bank, and the Royal Bank of Scotland) and four in Northern Ireland (Bank of Ireland, First Trust Bank, Danske Bank, and Ulster Bank) have retained the right to issue their own sterling banknotes (although they are now under the supervision of the Bank of England).
 
6
See The Economist, A Survey of the World Economy, Monetary metamorphosis, 23 Sept. 1999.
 
7
See Thornton, Henry, 1802: An Enquiry into the Nature and the Effects of the Paper Credit of Great Britain, Hatchard.
 
8
Ironically, around 100 years later, in 1995, the Barings Bank was ultimately brought down by again suffering massive losses on foreign investments. Specifically, Barings fell victim to one of their own employees crating a loss of around 1.4 billion US dollars through unauthorised speculation in Asian financial markets. Some parts of the bankrupt Barings Bank were sold to other commercial banks.
 
9
A twentieth-century proponent of a free-banking system was Friedrich August von Hayek, who emphasised the corresponding advantages in his book on ‘The Denationalization of Money’, published in 1976.
 
10
See, for example, Miron, Jeffrey A., 1986: Financial Panics, the Seasonality of the Nominal Interest Rate, and the Founding of the Fed, The American Economic Review 76, 12–140.
 
11
A list compiled by the Bank for International Settlements (BIS) currently contains around 200 central banks around the world.
 
12
This ratio is obtained by dividing 45 g of silver by 2.9 g of gold, that is 45∕2.9 ≈ 15.5.
 
13
The definitions of the actual mint regulations were complicated. Different currencies were defined in terms of gold of various fineness levels and according to different weights. For example, whereas the British mint regulation stipulated that ‘480 ounces troy of gold, 11∕12th fine, shall be coined into 1869 Sovereigns’, the French mint regulation said that ‘1000 g of gold, 11∕12th fine, shall be coined into 155 Napoleons (of 20 francs each)’. The mint-pars mentioned above use the conversion that a troy ounce equals 31.1035 g (see Clare, George, 1902: A Money-Market Primer and Key to the Exchanges, Effingham Wilson, p. 74).
 
14
See Eichengreen, Barry, 2000: Globalizing Capital—A History of the International Monetary System, Princeton University Press, pp. 24ff.
 
15
See Obstfeld, Maurice, and Allen M. Taylor, 2004: Global Capital Markets, Cambridge University Press, Chap. 2.
 
16
Quoted in The New York Times, October 16, 1929: Fisher sees stocks permanently high.
 
17
Quoted in Somary, Felix, 1960: The Raven of Zurich, C. Hurst, p. 147.
 
18
Quoted in Liaquat, Ahamed, 2009: Lords of Finance, Penguin Books, p. 432.
 
19
Of course, the Bretton Woods System only covered the Western Hemisphere. Although the Soviet Union did send a delegation to the international monetary conference in 1944, the communist countries installed a financial system, within which the state took full control over the distribution of money and the allocation of credit and foreign exchange. For the countries under the influence of communism, this choice meant that the entire financial and banking system was essentially socialised.
 
20
See Triffin, Robert, 1960: Gold and the Dollar Crisis, Yale University Press.
 
21
The reason that slightly positive levels of inflation are tolerated is that commonly used price indices tend to overestimate the actual changes in purchasing power. For example, a consumer-price index measures inflation through the average price of a fixed consumer basket and, hence, ignores possible quality improvements (which would partly justify higher prices), or that consumers can switch from expensive to cheaper products. Arguably, the resulting overestimation of inflation amounts to around one percentage point (Shapiro, Matthew, and David Wilcox, 1996: Mismeasurement in the Consumer Price Index: An Evaluation, NBER Macroeconomics Annual). In simple words, it can also be said that price stability is achieved when ‘ordinary people stop talking and worrying about inflation’ (this definition is attributed to Alan Blinder, who was a Vice Chairman of the Board of Governors of the Federal Reserve System).
 
22
Other criteria were set regarding the convergence of inflation and money-market interest rates within the European currency area.
 
Metadata
Title
A Brief History of Central Banks
Author
Nils Herger
Copyright Year
2019
DOI
https://doi.org/10.1007/978-3-030-05162-4_2